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Philipp Kurek and Pietro Grassi discuss the UK’s withdrawal from the Energy Charter Treaty in The Energy Industry Times

By Philipp Kurek & Pietro Grassi

Partner Philipp Kurek and Senior Associate Pietro Grassi examine the important implications for investors regarding the UK’s withdrawal from the Energy Charter Treaty.

Philipp and Pietro’s article was published in The Energy Industry Times, 23 March 2024, and can be found here

On 22 February 2024, the UK joined an ever-growing number of countries seeking to withdraw from the Energy Charter Treaty (“ECT”).

Whilst the UK’s withdrawal will not become effective until one year after it issues a formal notice of withdrawal, and even thereafter existing investments will continue to be protected by the ECT’s 20-year sunset clause, investors in the UK energy sector, as well as UK energy investors with investments in other ECT member states, are well advised to consider carefully the holding structures of their existing and any future investments to ensure continued protection of their investments under international law.

Moreover, given the growing number of countries withdrawing from the ECT in recent years, investors would be well advised to consider structuring or restructuring their investments to benefit from, and maximise, protections that are available under other international investment treaties.

The Energy Charter Treaty

The ECT is a multilateral trade and investment agreement applicable to the energy sector that was signed in 1994 and entered into force in 1998.

The ECT provides a framework for energy trade, transit and investment between signatory states and contains a number of important investment protections for qualifying investors from one ECT state investing in another ECT state.

In this respect, the ECT contains a very broad definition of protected investments, and includes (amongst other things) direct and indirect shareholdings, bonds, debt, contractual claims to money, and other tangible and intangible rights, in each case provided such investment is associated with an economic activity in the energy sector. Qualifying investors, on the other hand, are defined by their nationality / country of incorporation, though importantly the ECT allows states to deny the advantages of the ECT to a legal entity if it is owned or controlled by a person from a non-ECT state, and the entity has no substantial business activities within the relevant ECT state. In other words, structuring an investment via a pure holding/post-box company may not be sufficient to gain ECT protection.

As regards the substantive protections afforded by the ECT, which are in addition to, and sit alongside, any rights investors and their investments may enjoy under national laws, regulations, and/or contracts, the ECT contains important protections against the unlawful nationalisation of investments, and requires states to afford investments “fair and equitable treatment” (“FET”). The latter is an incredibly broad standard of protection which has been held to include (amongst other things) a protection of the investor’s legitimate expectations, an obligation to maintain a stable and predictable framework for investments, and a prohibition against discrimination and arbitrary conduct by the host state (including any organs of the state such as relevant ministries, regulators, and even the local courts).

Significantly, the ECT also gives investors the right to bring direct claims against the host state, and to pursue such claims in a neutral forum via international arbitration rather than having to submit the dispute to a state’s domestic courts.

Exodus of member states

Since its entry into force, the ECT has become one of the most litigated investment treaties in the world. As of December 2023, more than 160 arbitrations have been brought under the ECT.

Some high-profile claims under the ECT concerned the phase-out of nuclear energy, the implementation of coal-exit policies, and bans on the exploration and exploitation of oil concessions due to environmental concerns. However, the vast majority of claims under the ECT have been brought by investors with respect to the termination or review of incentives afforded to renewable energy producers.

It was in this context that the EU and its member states called for a modernisation of the ECT to include more robust provisions in the treaty with respect to climate change, sustainable development and clean energy transition, while at the same time ensuring that the right of states to regulate in the energy sector was respected.

However, efforts to modernise the ECT ultimately failed to reach the required majority to ratify changes to the treaty, leading to a raft of countries signalling their intention to withdraw from the ECT. France, Germany, and Poland ceased to be members of the ECT as of December 2023, whilst Luxembourg is set to withdraw in June 2024, Slovenia in October 2024, and Portugal in February 2025. Similarly, Spain, the Netherlands, and Denmark also announced their intention to withdraw from the ECT.

Moreover, in March 2024, officials from all 27 EU member states agreed in principle to a proposal from the European Commission for the EU’s withdrawal from the ECT, with the EU’s withdrawal still being subject to approval by the European Parliament and the EU Council. Importantly, however, the European Commission has taken the position that because areas covered by the ECT largely fall under exclusive EU competence, EU member states cannot remain contracting parties to the ECT once the EU has withdrawn unless they are authorised to do so by the EU.

Impact of the UK’s withdrawal on UK investors and foreign investors in the UK energy sector

The UK’s announcement that it intends to withdraw from the ECT therefore comes at a time of great uncertainty, amongst an ever-growing exodus from the ECT that raises questions about the ECT’s future as a whole.

In the short term, it is important to understand that the UK has not actually withdrawn from the ECT (yet). It has merely announced its intention to withdraw. In order for the UK’s withdrawal to take effect, the UK needs to make a formal notification of withdrawal, which will take effect one year after notification.

Furthermore, even when the UK actually withdraws from the ECT, the UK would remain subject to a 20-year sunset clause, which continues to protect investments existing at the time the withdrawal takes effect. However, any new investments made after the UK’s withdrawal would no longer benefit from ECT protection.

In light of these developments, investors in the energy sector would be well advised to consider carefully existing investment structures to ensure that investments are protected, and will continue to be protected, under international law.

In particular, given the uncertainties surrounding the future of the ECT more generally (including efforts by the EU to deny the application of the sunset clause in disputes between EU investors and EU member states), investors should consider whether investments could be restructured so as to benefit from protections afforded by other international treaties, such as those contained in one of the more than 2,000 bilateral investment treaties (“BITs”) in force around the world.

While some BITs (similar to the ECT) require investors to have substantial business operations in the relevant treaty state, many BITs do not contain such requirements. This enables investors to benefit from relevant protections by structuring investments via holding companies incorporated in protected jurisdictions.

In this respect, whilst it is not possible to restructure investments in such a manner once a dispute has arisen, pre-emptively (re)structuring investments in a manner that affords investment protections before a dispute becomes reasonably foreseeable is both permissible and – especially for investors in the UK and European energy sector – highly advisable.

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