energy charter treaty
Strategic choices under the ECT
David Herlihy and Bruce Macaulay of Skadden Arps Slate Meagher & Flom (UK) LLP
explain how to maximise protection under the treaty by effective pre- and post-investment planning
T
his article identifies strategic choices
faced by investors at two key stages in
the lifespan of an Energy Charter Treaty
investment: at the point when the investment is
initially structured and documented; and at a later
stage, when a dispute arises with the host state
concerning treatment of the investment.
Structuring the investment
At the pre-investment stage, the key objective is
to structure the investment in a way that qualifies
for Energy Charter Treaty protection. Careful
planning at the outset can lay the groundwork for
independent arbitration of subsequent disputes
with the host state.
In this respect, the Energy Charter Treaty
offers unparalleled scope for investment
protection planning in the energy sector. As with
bilateral investment treaties, it is not necessary
to acknowledge the applicability of the Energy
Charter Treaty in the investment contract itself.
The Energy Charter Treaty can therefore be a
silent ally of the investor during the contractual
negotiations. It may even enable the investor to
agree to dispute resolution procedures in the
contract which it would otherwise have rejected
in the absence of the treaty, possibly in exchange
for benefits elsewhere in the contract.
The Energy Charter Treaty differs, however,
from a bilateral treaty in its membership and
geographical scope. Fifty-one states have signed
or become parties to the Energy Charter
Treaty, of which 46 states have completed their
ratification or accession procedures. This makes it
the most significant multilateral investment treaty
in existence. Often misunderstood as a purely
European treaty, the Energy Charter Treaty in fact
covers not only the EU member states but also
a much wider area, including Central Europe,
Eastern Europe and Japan. The European Union
is also a contracting party to the Energy Charter
Treaty in its own right and can be sued directly
under the treaty. During 2007, an arbitral tribunal
hearing claims by Yukos shareholders is expected
to decide whether Russia is bound by the treaty
as a result of the provisional application clause in
article 45(1) of the treaty.
The practical consequence of this diverse
membership is twofold. First, it means that the
Energy Charter Treaty’s protections are available
in a very large number of states where foreign
26
firms might be contemplating an investment.
In particular, the Energy Charter Treaty
supplements the existing matrix of BITs and
can, in some cases, supply a remedy where none
would otherwise exist (eg, where the relevant
Energy Charter Treaty states have not entered
into any BIT with one another). Second, it
gives investors a wide choice of countries in
which to incorporate their investment vehicles.
Thus, although investment treaty protection will
almost never be the driver for a corporate deal
structure, the Energy Charter Treaty is flexible
enough to offer investment protection solutions
without sacrificing other project goals such as tax
efficiency.
It should be noted,
however, that what the
Energy Charter Treaty
gives with one hand it
sometimes takes away
with the other
Defining ‘investment’ and ‘investor’ – who is
entitled to claim the benefits of the Energy
Charter Treaty?
Turning to specifics, the key to unlocking the
Energy Charter Treaty’s investment protections
lies in article 1 of the treaty. The article extends
the treaty’s coverage to an ‘investment’ owned
or controlled by an ‘investor’ which has been
made in the area of an Energy Charter Treaty
contracting party. The definitions of ‘investment’
and ‘Investor’ are critical.
Investment is defined with great breadth as
“every kind of asset, owned or controlled directly
or indirectly by an Investor.” In a non-exhaustive
list, article 1 identifies various qualifying assets
such as tangible and intangible property; shares,
stocks, or other forms of equity participation;
claims to money and claims to performance
pursuant to a contract; intellectual property;
returns; and rights conferred by law or contract
such as licences and concessions.
The limiting factor in article 1 is that the
investment must be “associated with an Economic
Activity in the Energy Sector” which means that
it must relate to “the exploration, extraction,
refining, production, storage, land transport,
transmission, distribution, trade, marketing, or
sale of Energy Materials and Products.” This
extends the treaty’s protections to a wide range of
projects based on fossil fuels (such as oil, gas, coal
and liquefied petroleum gases) as well as nuclear
materials, renewable energy sources and electricity.
The Energy Charter Treaty thus protects a
great range of activities, including projects to
prospect for oil, gas, coal or uranium, projects to
construct and operate a power plant (including
those based on wind and other renewable energy
sources), projects to construct and operate a
power grid or oil or gas pipelines, the removal
of waste from energy-related facilities, the
decommissioning of energy-related facilities, the
marketing of energy products (such as the retail
of gasoline), and all research, consulting, planning,
management and design relating to the foregoing
activities.
It should be noted, however, that what the
Energy Charter Treaty gives with one hand it
sometimes takes away with the other. Throughout
the treaty, various rights are cut back through a
labyrinth of annexes that contain exceptions and
carve-outs (usually included to accommodate
concerns expressed by various national delegations
during the treaty’s negotiation). One such
exception lies in annex NI, which states that the
treaty’s investment protections do not apply to
investments relating to fuel wood and charcoal.
Assuming that the project qualifies as an
investment, the next crucial planning stage is to
ensure that the investment is made by a qualifying
investor. An investor for Energy Charter Treaty
purposes is defined as either:
•a company or other organisation structured
Volume 2 • Issue 2
in accordance with the laws of an Energy
Charter Treaty contracting party; or
•(in the case of natural persons) a citizen,
national or permanent resident of an Energy
Charter Treaty contracting party,
provided in both cases that the investor is not
a national of the host state.
In contrast to some bilateral investment treaties,
there is no requirement that the investment
vehicle must have its ‘social seat’ or ‘effective
centre of management’ in an Energy Charter
Treaty contracting party. Incorporation in
an Energy Charter Treaty contracting party
is sufficient (although this is subject to one
limitation, considered below).
Moreover, the explicit reference in article
1 to investments being “owned or controlled
directly or indirectly” gives even further latitude
to investors to arrange their investment holdings
through tax-efficient structures without losing
treaty protection. The Energy Charter Treaty
investor can be either the direct holder of the
shares in the enterprise, or it can be a shareholder
higher up the corporate chain. Thus, for example,
the broad language of article 1 enables investors
of non-Energy Charter Treaty countries (such as
the United States) to incorporate their investment
vehicles in an Energy Charter Treaty contracting
party and thereby gain treaty protection.
One important exception lies in article 17,
which gives Energy Charter Treaty contracting
parties the right to deny treaty protection
to so-called ‘mailbox’ companies with “no
substantial business activities” in their country of
incorporation. Energy Charter Treaty contracting
parties must positively exercise this carve-out
if they want to rely on it; otherwise the default
rule applies under which mere incorporation
of the investment vehicle in an Energy Charter
Treaty contracting party will be sufficient. This
was illustrated in Plama Consortium Limited v
Bulgaria (ICSID case No. ARB/03/24, decision
on jurisdiction of 8 February 2005), where
Bulgaria sought to exercise its right under article
17 after an investor had already commenced
arbitral proceedings under the Energy Charter
Treaty. In its decision on jurisdiction, the Plama
tribunal held that a state cannot invoke the denial
of benefits clause in article 17 retrospectively
to defeat an existing treaty claim. The tribunal
went even further when it suggested that any
application of article 17 was permissible only
before the investment itself had been made,
because any contrary conclusion would defeat the
legitimate expectations of an investor.
The Plama decision, however, is not a binding
interpretation of the Energy Charter Treaty and
another tribunal could take a different view. If
possible, therefore, an investor using a ‘mailbox’
company for Energy Charter Treaty jurisdiction
should obtain a written commitment from the
host state that it will not invoke article 17 to deny
global arbitration review
energy charter treaty
the benefits of the Energy Charter Treaty to the
investment in question.
Planning a dispute resolution strategy
Step one: identifying available rights and
dispute resolution procedures
We now fast-forward to the point where the
investment has been made and a dispute arises
with the host state (or an entity whose conduct is
attributable to the host state under international
law). In this event, the investor’s first task is to
The broad language
of article 1 enables
investors of non-Energy
Charter Treaty countries
to incorporate their
investment vehicles
in an Energy Charter
Treaty contracting party
and thereby gain treaty
protection
identify its sources of legal rights and the forums
in which those rights can be enforced. Turning to
the first, Stephen Jagusch and Anthony Sinclair’s
article ‘Gateways to the Energy Charter Treaty’
on page 18, has already outlined the scope of
investment protections granted by part III of the
Energy Charter Treaty. We will not repeat them
here. That said, from a strategic perspective, it is
important to recall that the rights contained in
part III of the Energy Charter Treaty, though
valuable, will rarely be the only rights available to
an investor. The investor will usually have other
substantive rights under contract, domestic law,
customary international law and, in some cases,
a bilateral investment treaty. All of these rights
should be analysed in tandem with part III of the
Energy Charter Treaty.
The choice of available forums is just as
important. An investor will often have to decide
between pursuing international arbitration under
the Energy Charter Treaty, a bilateral investment
treaty or an investment contract. The investor may
also have a right under domestic law to litigate in
the host state’s courts. Identifying and prioritising
these choices at the outset is critical to developing
a successful dispute resolution strategy.
For example, it is not uncommon for an
Energy Charter Treaty dispute to be preceded by
domestic litigation or contractual arbitration. The
two can even run in parallel, as has been done
in at least one Energy Charter Treaty arbitration.
The Energy Charter Treaty does not automatically
prevent a foreign investor from pursuing these
avenues in addition to Energy Charter Treaty
arbitration. The strategic question for the investor
becomes which routes to pursue and in what
sequence?
The starting point for the investor’s strategy
is article 26 of Energy Charter Treaty. A trap
for the unwary lies in the ‘fork-in-the-road
clause’ contained in article 26(3)(b)(i). If the
clause applies, an investor that submits a dispute
to the host state’s courts or to a previously
agreed dispute settlement procedure (such as
an arbitration agreement in the investment
contract) cannot later submit the same dispute to
international arbitration under article 26 of the
Energy Charter Treaty.
Article 26(3)(b)(i) merits two comments. First,
it does not apply to all Energy Charter Treaty
contracting parties, but only to those listed in
annex ID. (The list of countries includes Australia,
Azerbaijan, Bulgaria, Croatia, Cyprus, the Czech
Republic, the European Communities, Finland,
Greece, Hungary, Ireland, Italy, Japan, Kazakhstan,
Mongolia, Norway, Poland, Portugal, Romania,
Russia, Slovenia, Spain, Sweden and Turkey). If a
contracting party has not exercised the right to
join annex ID, then the text of article 26 appears
to give the investor the right to seek international
arbitration of a treaty dispute even where it has
previously submitted the treaty dispute to another
forum.
This view was confirmed in one of the first
awards rendered under the Energy Charter Treaty
(Petrobart Ltd v Kyrgyzstan, award of 29 March
2005), where the tribunal remarked that “even if
Petrobart had submitted its claims based on the
Treaty to any of the above for a (ie, domestic
court or UNCITRAL arbitration) [...] subsequent
submission to arbitration under Article 26 [of
the Energy Charter Treaty] would still have
been permissible. This would have been the case
because [...] the Kyrgyz Republic chose not to be
listed in Annex ID of the Treaty.”
Second, a dispute with a host state can easily
be packaged into multiple ‘legal disputes’, each
dependent on separate rights under contract,
national law and international law. Article 26
extends only to disputes concerning an alleged
breach by the host state of part III of the Energy
Charter Treaty. Many recent cases have turned
on the distinction between claims founded on
national laws or contracts, and treaty claims. Those
decisions have tended to hold that the submission
of contractual disputes to the domestic courts
of a host state is no bar to submitting a treatybased claim to an international tribunal, because
the two disputes are distinct. (See, for example
Azurix Corp v The Argentine Republic, ICSID case
27
energy charter treaty
No. ARB/01/12, decision on jurisdiction of 8
December 2003, 43 ILM 262 (2004)). Under that
body of case law, the fork-in-the-road is never
reached unless a breach of the treaty is pleaded in
the first forum. (For a similar view, see ‘InvestorState Dispute Resolution under the Energy
Charter Treaty: Which Fork? Which Road?’, M
Polkinghorne, Mealey’s Int Arb Rep volume 19 No.
4 page 34 (2004)).
Step two: formulating a strategy
Having identified the sources of its legal rights
and the available forums, the investor will next
have to decide whether to pursue its Energy
Charter Treaty claims before, after or in tandem
with its domestic law or contractual claims; and
whether to invoke the arbitration mechanism in
article 26 of the Energy Charter Treaty or seek to
have its claims heard in another forum.
If the investor’s objective is to apply
maximum pressure, then the prospect of multiple
proceedings may contribute to that aim. For
example, the investor might decide to bifurcate its
Energy Charter Treaty claims from any domestic
litigation or contractual arbitration. This has
the advantage of keeping a second avenue open
(usually with a differently constituted tribunal)
in the event that the first set of proceedings is
unsuccessful or yields a damages figure less than
that recoverable under the Energy Charter Treaty.
The Energy Charter Treaty’s text does
not require an investor to raise alleged treaty
breaches in any court or arbitral proceedings
that might precede an arbitration commenced
under article 26. The Petrobart tribunal explicitly
rejected any attempt to graft a collateral estoppel
principle into the text of article 26, and held
that “the Arbitral Tribunal finds no provision in
the [Energy Charter Treaty] which would have
obliged Petrobart to raise the Treaty issues in the
domestic proceedings or the previous arbitration
proceedings, both of which concerned the
application of domestic law.”
The converse is also true: submitting a
dispute to arbitration under article 26 does not
preclude an investor from turning to litigation or
a contractual dispute resolution mechanism at a
later point. The Energy Charter Treaty differs in
this respect from other investment treaties such as
NAFTA article 1121, which requires a claimant
to waive “its right to initiate or continue before
any administrative tribunal or court under the
law of any Party, or other dispute settlement
procedures, any proceedings with respect to the
measure of the disputing Party that is alleged to
be a breach [of NAFTA Chapter 11].” This may
be particularly helpful where, for example, the acts
are found not to have risen to the level of a treaty
violation, but might still be a breach of contract
or domestic law.
Nevertheless, multiple proceedings carry
multiple risks. Even if the fork-in-the road clause
in article 26(3)(b)(i) is out of the picture because
28
the host state is not listed in annex ID, submitting
Energy Charter Treaty claims to the host state’s
courts or to an arbitral tribunal constituted under
an investment contract can raise difficulties in
a subsequent arbitration commenced pursuant
to article 26 of the Energy Charter Treaty. In
particular, it raises the likelihood of a defence
that the issues in dispute are subject to the
principles of res judicata or issue estoppel. The
same risk arises to a lesser degree from pursuing
domestic law or contractual claims in a separate
forum, since adverse findings on issues in those
proceedings might affect a tribunal’s analysis of
issues under part III of the Energy Charter Treaty.
For example, a finding that there was no breach of
contract or domestic law by the host state could
The Petrobart tribunal
explicitly rejected
any attempt to graft
a collateral estoppel
principle into the text of
article 26
affect a tribunal’s analysis of expropriation claims
under article 13 of the Energy Charter Treaty or
claims under the umbrella clause in article 10.
A further option arises in cases where the
investment is protected by both the Energy
Charter Treaty and another investment treaty
(usually a bilateral investment treaty). In that
event, an investor can decide to start proceedings
under both treaties and seek to have them heard
by the same tribunal (as done in at least two
Energy Charter Treaty cases: Plama Consortium
Ltd v Bulgaria and Kardassopoulos v Georgia).
This approach has the benefit of consistency
and efficiency. Alternatively, an investor might
decide to have the treaty claims heard by separate
tribunals. This may increase the chances of an
adverse finding against the host state, will increase
both sides’ costs and, in the process, may add
pressure to reach a settlement.
If the investor’s goal is to resolve the dispute
efficiently and at the lowest cost, it may be
possible to include its Energy Charter Treaty
claims within domestic litigation or possibly
contractual arbitration. In the first scenario – that
is, the investor chooses to litigate in the host state’s
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courts – the Energy Charter Treaty claims may
be included if the treaty has been incorporated
into the domestic law of the host state and can
be applied directly by its courts. This is a question
of national law in each Energy Charter Treaty
contracting party. Even then, however, suing the
host state in its own courts is rarely considered
preferable to international arbitration.
Otherwise – where for example the
investment contract is entered into with the state
itself and contains an arbitration clause – the
Energy Charter Treaty claims can be arbitrated as
part of that procedure so long as the arbitration
clause is drafted broadly enough to encompass
all claims “relating to” or “connected with” the
contract. This permits the same tribunal to hear
both contractual and treaty claims and eliminates
the chance of inconsistent outcomes.
Having outlined both of these scenarios,
we should note that pursuing either is relatively
uncommon. The more usual avenue for bringing
Energy Charter Treaty claims is to commence
a treaty-based arbitration through the consent
mechanism contained in article 26 of the Energy
Charter Treaty itself.
In this respect, article 26(4) gives investors
a range of options for resolving Energy Charter
Treaty disputes. It is clearly drafted in favour
of investors and gives them the choice either
to litigate in the host state’s own courts; to
resolve the dispute through a previously agreed
mechanism; or (as is most common) arbitrate
through either ICSID arbitration, arbitration
under the ICSID Additional Facility Rules,
UNCITRAL arbitration, or arbitration under
the Stockholm Chamber of Commerce Rules. A
detailed assessment of each institution is beyond
the scope of this article and has been addressed at
length elsewhere. Nevertheless, we pause to note
that arbitration under the ICSID Convention will
be available only where the nationality and subject
matter requirements in article 25 of the ICSID
Convention are satisfied. Russia, for example,
is not an ICSID contracting state and Energy
Charter Treaty proceedings against it are therefore
confined to one of the other three options.
***
After years of relative obscurity, the Energy
Charter Treaty has now emerged as a central
component in the law protecting investments
in the energy sector. No other legal instrument
combines its breadth of application and depth
of substantive investment protections. As a result,
the Energy Charter Treaty offers unparalleled
opportunities for investors in the energy sector
to protect their foreign investments and enforce
those protections through international arbitration.
But the key to maximising the benefits of the
Energy Charter Treaty lies in thoughtful planning
when structuring the initial investment, and
chess-like strategy at the outset of any subsequent
dispute.
Volume 2 • Issue 2