Critical Analysis Of The Modernisation Of The Denial Of Benefits Clause In The Energy Charter Treaty
Keywords: Energy Charter Treaty, Denial of Benefits, Article 17, Investor, European Union
I. Introduction
Bilateral and multilateral investment treaties (“BITs” and “MITs”) usually have broad definitions of ‘investor’. Historically, one of the reasons for such a broad definition is to provide a greater incentive to a prospective investor to invest in the host state etc. However, as the jurisprudence evolved, multinational companies started taking advantage of such definitions due to their cross-border operations. In other words, investors planned their corporate structures to indulge in ‘treaty-shopping’ or to raise national claims to the status of treaty obligations. Therefore, to discourage such practices, some states started incorporating a denial of benefits (“DOB”) clause to de facto curtail the definition of an investor.[i]
A DOB clause usually provides for two grounds when the host state may deny protection to an investor namely, where the investor is a national of a third state that does not have substantial commercial activities in the host state or that the host state does not maintain good ‘diplomatic relations’ with such a third state.[ii] It can be seen that the first scenario refers to an economic connection between the investor and the state whereas the second scenario is associated with the diplomatic relations between the host state and the third state. In practice, it has been generally seen that the second scenario has almost never been invoked and it is the first scenario that has been raised by states to deny benefits to the claimant investor.[iii] Therefore, in essence, a DOB clause denies protection to mailbox and shell companies.
At this juncture, it is noteworthy to question here as to why a DOB clause needs to be incorporated when the states can simply agree upon a narrower definition of an investor. The answer to this question lies in the fact that DOB clause is usually a discretionary clause. In other words, while a narrower investor clause would also deny benefits to investors which are not shell companies, a DOB clause allows the host state to decide on a case to case basis, subject to fulfillment of stipulated pre-conditions, regarding whether the investor in question is a legitimate investor or a mere shell company.[iv]
The Energy Charter Treaty (“ECT”)[v] has proved to be one of the most important sources for the development of jurisprudence on the DOB clause. Art. 17 of the ECT provides for the DOB clause. It has been seen that much of the jurisprudence interpreting Art. 17 of the ECT has favoured the investors.[vi] Consequently, in May 2020, the European Union proposed some amendments, which included the amendment of Art. 17 of the ECT (“EU proposal”).[vii] However, not much attention has been paid to this proposal after its release. Therefore, this paper discusses the jurisprudence of Art. 17 of the ECT and comments on the EU proposal to analyze its impact on the future of ECT and the DOB clause.
II. Contemporary Jurisprudence
Before examining the EU proposal, it would be useful to examine the existing jurisprudence pertaining to the interpretation of Art. 17.
The first case interpreting Art. 17 of the ECT was Plama Consortium Limited v. Republic of Bulgaria (“Plama”).[viii] In this case, the argument was that the claimant had no substantial commercial activities in Cyprus and hence, it had been denied the benefits of the ECT by the respondent state. In this respect, the tribunal firstly held that the use of the expression ‘this part’ and a reading of the title of Art. 17 indicates that the DOB clause cannot be invoked as a jurisdictional objection but is to be examined on the merits of the case.[ix] Additionally, the tribunal contrasted the language of Art. 17(1) of the ECT with ASEAN[x], and held that given the use of the phrase ‘reserves the right’, the host state is required to exercise its right.[xi] In other words, the right to deny benefit may exist but it comes into play only when it is exercised by giving a notice to the investor. The tribunal further held that such notice cannot be applied retrospectively as it would violate the legitimate expectations of the investors and such information should be available to the investors prior to making the investment.[xii] Therefore, the argument invoking Art. 17 of the ECT was rejected.
Interestingly, in a BIT arbitration containing a DOB clause that employs similar language as to Art. 17 of the ECT, the tribunal held that the requirement of prior notice cannot be read into the DOB clause unless expressly provided.[xiii] However in response, commentators opine that the multilateral nature of the ECT is one of the reasons for the present jurisprudence to encompass contrasting approaches which may be adopted by various states.[xiv]
An interesting question regarding the interpretation of Art. 17 arose in the Yukos case.[xv] In this case, the issue was whether a contracting party can be a ‘third state’ in the context of Art. 17. It was alleged that the claimant Yukos was a company incorporated in Cyprus but controlled by Russian nationals. Therefore, it was argued that as ‘investors’ of Cyprus, control by nationals of the Russian Federation amounted to control by a third state. However, the tribunal disagreed with this argument and held that the term ‘third state’ is equivalent to ‘non-contracting party’ to the ECT.[xvi] Since Russia is a contracting party to the ECT, the DOB clause could not be exercised against such a state.
The current jurisprudence has received mixed reactions from the arbitral community. Some scholars have opined that the notice requirement is impractical as most states would only come to know about such scenarios once the dispute has arisen.[xvii] On the other hand, whilst acknowledging these shortcomings, it has also been opined that the existing jurisprudence is correct in law as the investor stands in a weaker position compared to the host state and any doubts regarding the interpretation of the treaty should be resolved in the favour of the investor.[xviii]
It is noteworthy to mention here that despite the scholarly debate, the current jurisprudence has remained consistent and has been largely followed by subsequent tribunals. [xix]
III. Analysis of the EU Proposal
The previous section has shown that in practice, the current DOB jurisprudence with respect to the ECT is heavily prejudiced against the host state. Therefore, even though not expressly stated in the EU proposal, it is logical to imply that the EU proposal takes into account the lessons learned from the existing jurisprudence.
The first notable change with the respect to Art. 17 proposed by the EU reads as ‘Each Contracting Party may deny the application of this Part and of Articles 26 and 27 of this Treaty….’ (Emphasis and strikethrough original). At the first blush, this amendment appears to undo the Plama jurisprudence. This change would effectively raise a DOB objection to the stage of a jurisdictional objection. However, it is not clear whether the addition of the phrase ‘may deny’ would put an end to the prior notice requirement. This is because, on the one hand, it can be opined that a conscious amendment to the language of ECT implies that the states wanted to do away with the prior notice requirement. On the other hand, the use of the word ‘may’ indicates a discretion that needs to be exercised at the option of the host state. However, this ambiguity is ameliorated to some extent by incorporating a clarification at the end of Art. 17 which reads as ‘For greater certainty, a Contracting Party may deny such benefits without any prior publicity or additional formality related to its intention to exercise the right conferred by this Article.’ Therefore, in the author’s opinion, the proposed amendment implies the discretion to deny benefits under Art. 17 rests with the host state and needs to be exercised. Furthermore, even though the requirement of formal notice cannot be read into the proposed Art. 17 but nevertheless, an intention to deny such benefits must be shown by the host state. At this juncture, it is opined here that it is plausible that the host state may prove its intention by exercising its discretion at the time of notice of commencement of arbitration proceedings. However, it is equally plausible that the tribunals still hold that legitimate expectations of the investors mandate the host state to manifest its intention at the time of making the investment.
Another noteworthy aspect of the EU proposal is that it eliminates the ‘substantial business activities’ ground from Art. 17. Instead, the EU proposal proposes an amendment of the definition of ‘investor’ under Art. 1(7) to add the requirement of carrying on substantial business activities in the host state to qualify as an investor. This implies that the EU wants to elevate the economic connection test to a ratione personae requirement so as to automatically exclude treaty shopping claims and shell company claims. Though this technique may be novel, however, an ECT conference document has shown that some member states like Turkey are in the favour of retaining the economic connection test within the ambit of Art. 17.[xx] Moreover, countries like Japan are in favour maintaining the status quo of Art. 17.[xxi] Nevertheless, all the contracting parties seem to agree on removing the notice requirement for the exercise of the DOB clause.[xxii]
The next point requiring comment is the addition of new grounds for exercising a DOB clause. The EU proposal suggests that a DOB clause may be exercised when the Contracting party adopts measures pertaining to ‘…the maintenance of international peace and security, including the protection of human rights….’ Similar amendments are also found in other parts of the EU proposal such as the preamble and insertion of a new article pertaining to sustainable development. In this author’s opinion, this appears to be part of the larger EU initiative to implement the UN Guiding Principles on Business and Human Rights[xxiii] and to create additional obligations on the investors to pay due regard to human rights which may be violated due to indiscriminate use of fossil fuels or other activities in the energy sector.
IV. Conclusion
Jurisprudentially, the EU proposal would result in a complete makeover of the DOB clause. On the one hand, the addition of protection of human rights as a ground to exercise DOB is certainly a new development in the investment law regime. On the other hand, raising the economic connection test to a ratione personae status overlooks the very purpose for which the device of a DOB clause was devised.
It is undeniable that the EU is a significant member of the ECT. Moreover, rumors of the EU exiting from the ECT regime[xxiv] certainly pressurize other contracting parties to agree upon the EU proposal. However, in respect of the DOB clause, the EU seems to have taken a very rigid approach without taking into account the purpose of a DOB clause and the plurilateral nature of the ECT. Since any amendment to the ECT requires the consent of all contracting parties,[xxv] it seems unlikely that the EU proposal will be accepted in wake of the difference of opinions.
This has been written by Meenal Garg, an LLM graduate from National Law School of India University, Bengaluru. Mr. Garg is currently working as an associate at KN Legal, New Delhi.
Preferred Citation: Meenal Garg, “Critical Analysis of the Modernisation of the Denial of Benefits Clause in the ECT” (ICAR, 28 April 2022) <https://investmentandcommercialarbitrationreview.com/?p=802>.
ENDNOTES
[i] Rudolf Dolzer and Christoph Schreuer, Principles of International Investment Law (OUP 2008) 55.
[ii] Rachel Thorn and Jennifer Doucleff, ‘Disregarding the Corporate Veil & Denial of Benefits Clauses: Testing Treaty Language & the Concept of “Investor”’ in Michael Waibel et al (eds), The Backlash against Investment Arbitration 10 (2010).
[iii] See Jorun Baumgartner, Treaty Shopping in International investment Law (OUP 2017) 116.
[iv] See ‘Recent Efforts to Curb Investment Treaty Shopping: How Effective are They?’ (2021) 38 Journal of International Arbitration 511, 518.
[v] Energy Charter Treaty (adopted 17 December, 1994) 34 ILM 360 (ECT).
[vi] See eg Plama Consortium Limited v. Republic of Bulgaria, ICSID Case No. ARB/03/24, Decision on Jurisdiction (8 February 2005).
[vii] ‘EU Text Proposal for the Modernisation of the Energy Charter Treaty’ (European Commission) <https://trade.ec.europa.eu/doclib/docs/2020/may/tradoc_158754.pdf> accessed 12 February 2022.
[viii] Plama Consortium Limited v. Republic of Bulgaria, ICSID Case No. ARB/03/24, Decision on Jurisdiction (8 February 2005).
[ix] ibid [147, 149-50].
[x] ASEAN Framework Agreement on Services (signed 15 December 1995) <https://asean.org/wp-content/uploads/2021/08/ASEAN-Framework-Agreement-on-Services-AFAS.pdf> accessed 17 March 2022.
[xi] Plama Consortium (n 7) [155-58].
[xii] ibid [161-62, 165].
[xiii] Guaracachi America Inc. v. Plurinational State of Bolivia, PCA Case No. 2011-17, Award (31 January 2014) [376-79].
[xiv] Lindsay Gastrell and Paul-Jean Le Cannu, ‘Procedural Requirements of “Denial-of-Benefits” Clauses in Investment Treaties: A Review of Arbitral Decisions’ (2015) 30 ICSID Review- Foreign Investment Law Journal 78, 95
[xv] Yukos Universal Limited v. Russian Federation, PCA Case No. AA 227, Award on Jurisdiction and Admissibility (30 November 2009).
[xvi] ibid [544-46].
[xvii] Thorn and Doucleff (n 2) 26.
[xviii] Elvira R. Gadelshina, ‘Burden of Proof under the “Denial of Benefits” Clause of the Energy Charter Treaty: Actori Incumbit Onus Probandi?’ (2012) 29 Journal of International Arbitration 269, 277.
[xix] See e.g. Masdar Solar and Wind Cooperatief UA v Kingdom of Spain, ICSID Case No ARB/14/1, Award (16 May, 2018) [69-76]; Khan Resources Inc v Government of Mongolia, PCA Case No. 2011-09, Decision on Jurisdiction (25 July 2012).
[xx] ‘31st Meeting of the Energy Charter Conference’ (Euractiv, 16 December 2020) <https://www.euractiv.com/wp-content/uploads/sites/2/2020/12/ECT-report-on-progress-made_FS.pdf> accessed 12 February 2022.
[xxi] ibid.
[xxii] ibid.
[xxiii] ‘Guiding Principles on Business & Human Rights’ (United Nations Human Rights Office of the High Commissioner, 2011) <https://www.ohchr.org/documents/publications/guidingprinciplesbusinesshr_en.pdf> accessed 12 February 2022.
[xxiv] Elena Sánchez Nicolás, ‘Calls for EU to Quit Energy Treaty over Lack of Progress in Talks’ (EU Observer 7 July 2021) <https://euobserver.com/climate/152361> accessed 12 February 2022.
[xxv] Energy Charter Treaty (adopted 17 December, 1994) 34 ILM 360 (ECT) art 36.
The views and opinions expressed in the article are those of the Author(s) solely and do not reflect the official position of the institution(s) with which the Author(s) is /are affiliated. Further, the statements of the Author(s) produced herein should not be construed as legal advice.
