Climate change is an all-encompassing global phenomenon that impacts every area of law and policy. International arbitration is no exception.
In line with the 2015 Paris Agreement goal to limit global warming to well below 2, preferably 1.5 degrees Celsius compared to pre-industrial levels, many governments have adopted ambitious net-zero targets and taken bold measures to achieve these. Often, such measures require companies to adjust to new ways of doing business, producing goods, and delivering services. This, in turn, impacts the short-term profitability and has the potential to affect the long-term prospects of success of the business, especially in carbon-intensive industries such as energy production and transport.
With increasing frequency, investors have been challenging States’ climate-aligned measures by alleging breaches of investment protections that the same States afforded them under investment treaties several decades ago. In their defence, States tend to turn to legal principles that stem from other areas of international law and are often untested in the context of international investment arbitration. This article addresses the pertinent questions that arise when international investment norms confront non-investment principles – what is the significance of this clash in the worldwide effort to combat climate change? How can it be reconciled? And, most importantly, does this conflict of norms make international arbitration a friend or a foe in the fight against climate change?
Climate change and international investment arbitration
The 21st century world is connected by a complex network of bilateral and multilateral investment treaties. The Database of Bilateral Investment Treaties, maintained by the International Centre for Settlement of Investment Disputes (“ICSID”), lists more than 3,000 bilateral investment treaties (“BIT(s)”). In addition to BITs, multilateral investment treaties (“MIT(s)”), such as the Energy Charter Treaty (“ECT”), are designed to facilitate investments among multiple parties in similar ways that BITs do between two States. Both BITs and MITs have a simple goal – to attract foreign direct investment and stimulate the domestic economies of capital-importing countries. In order to do so, they provide capital importers – the investors – with significant legal protections against certain obstacles, such as discriminatory and unfair treatment, illegal expropriation, or a more favourable treatment by the State of its own nationals, or nationals of third countries. Importantly, most of these treaties were concluded between the 1980s and 2000s and are silent on the subject of climate change.
Nonetheless, the keyword “renewable energy” returns 58 cases in ICSID Case Database, while the Grantham Research Institute reports that between 2012 and June 2021, at least 13 climate-related investor-State dispute settlement (ISDS) cases have been filed. In the majority of these, investors have challenged policy changes that governments made in order to meet their climate commitments. Although making up a minority of the 1,023 ISDS disputes submitted by the end of 2019, the trend of arbitrating climate disputes is undeniably on the rise. In January 2020, at least 173 of ongoing ISDS cases (representing 17% of all ISDS proceedings) related in some way to investments in fossil fuel industries, one of the sectors most threatened by climate policy responses. Against the background of the upcoming COP26 climate talks in Glasgow, UK, and signals of a green post-pandemic recovery, there is little doubt that greater numbers of climate-related disputes will arise between States and investors in the years to come.
The old ways of international investment arbitration
Well before 2012, ISDS tribunals had been asked to address conflicts between international investment law and non-investment legal principles. Such conflicts arise relatively often between BIT/ MIT obligations and those created under other international treaties. The reason for this is inherent in the fragmented order of international law – unlike domestic law, international law has no centralised legislative body that could address these conflicts systematically, nor is there a rule that multilateral treaties automatically prevail over bilateral, synallagmatic ones.
As a result, arbitration tribunals alone have been called upon to resolve these conflicts. It is crucial to examine interpretative approaches adopted in these early “conflict cases”, as they may be indicative of how tribunals could address the norm conflicts in ongoing ISDS climate-related disputes. Although international law contains many principles for resolving conflicting laws (such as lex superior, lex specialis, or giving effect to the intention of the parties to conflicting treaties), these have proved of little use for resolving conflicts between investment and non-investment norms. Instead, investment tribunals have developed their own conflict rules, often relying on the jurisprudence of the International Court of Justice and the World Trade Organisation.
One such rule was adopted in the 1992 case of SPP v Egypt, in which the tribunal found that the State’s investment obligations prevailed over its obligation to protect a cultural site under the 1972 UNESCO Convention. The tribunal based its decision on the fact that the conflict between the two obligations arose from the conduct of the State itself, more specifically Egypt’s decision to apply for the inclusion of the Pyramids area as a protected site under the UNESCO Convention. The conflict principle derived from this case is relatively simple – a State that has assumed investment obligations cannot displace these by entering at its own initiative into a subsequent conflicting non-investment commitment.
Another conflict rule derives from the 2000 case of S.D. Myers Inc. v Canada, where the tribunal examined motivations behind regulatory measures adopted under a conflicting non-investment obligation. On the facts of this particular case, the tribunal found that the Canadian government’s true incentives for banning the export of an environmentally hazardous chemical compound to the US were, in fact, discriminatory. The government’s reliance on international environmental obligations to justify the export ban was, in fact, an argument of last resort, while its true intention was to shield Canadian waste treatment businesses from US competition. This approach indicates two points – first, that tribunals are willing to take non-investment norms into account when assessing an alleged breach of investment protection; and second, that if such a norm is implemented with discriminatory intent, it will not prevail over pre-existing investment protection.
Finally, the 2003 case of Tecmed v Mexico lays down a conflict rule which focuses on the fair expectations of the investor at the time it made the investment. According to this conflict rule, which the tribunal established when it discussed legitimate expectations as a requirement under the Fair and Equitable Treatment standard that was embedded under Article 4(1) of the Spain-Mexico BIT, if the investor could fairly anticipate at the time of making the investment that the capital-importing State would later be under a conflicting non-investment obligation, whether or not voluntarily assumed, the non-investment obligation should prevail. Although not applicable on the facts of the case, this principle can also be justified on the basis of risk assumption – if the investor when making the investment had information available to it to anticipate the State’s conflicting obligation and nevertheless decided to go ahead with its investment, then the investor has, by implication, assumed the risk associated with such conflicting obligation.
The triumph of investment norms over non-investment ones in these awards led some early commentators to conclude that there is a limited scope to give effect to non-investment principles in the interpretation and application of international investment law.
The new ways of international investment arbitration
Arguably the easiest way to address the conflict between investment and non-investment legal principles is to renegotiate BITs and MITs and agree on clear conflict rules. However, there are some significant barriers to this solution – international negotiations are notoriously lengthy, costly, and often unsuccessful. The Comprehensive Economic and Trade Agreement between Canada and the EU, for example, took 15 years to negotiate and has been implemented only provisionally since 2017 due to discord among some EU member States. Critically, this snail-like pace conflicts with the urgency of tackling climate change. According to the recent Sixth Assessment Report published by Intergovernmental Panel on Climate Change (IPCC), a UN body tasked with assessing climate science, the next decade will be crucial to the success (or otherwise) of the world’s response to climate change.
Equally, exiting from an investment treaty is not a silver-bullet solution either – the majority of BITs contain so-called “sunset provisions” which keep the treaty in force vis-à-vis pre-existing qualifying investments for a number of years following a State’s withdrawal. Article 47(3) of the ECT, for instance, provides continuous protection to investments that were made before the State’s withdrawal from the treaty for 20 years. As a result, investment tribunals adjudicating climate-related disputes are likely to find more guidance on conflict rules in previous cases than in treaty provisions.
Although international arbitration does not recognise the doctrine of precedent, existing case law is often looked at as a source of inspiration for reasoning and interpretation in ongoing disputes. Therefore, the conflict rules developed in SPP v Egypt, S.D. Myers Inc. v Canada and Tecmed v Mexico may allow tribunals to accommodate non-investment norms, such as human rights or environmental principles, in their interpretation of investment obligations in ways that could expose certain anachronistic aspects of such obligations. The ongoing case of RWE v Netherlands is considered as an example.
In February 2021, German energy group RWE sued the Dutch government under the ECT, alleging that the country’s recently announced plan to phase out coal production by 2030 will render its investment in the coal industry worthless without adequate compensation (which, the company claims, would amount to €1.4 billion). The Dutch phase-out policy, however, is a direct response to the 2019 Urgenda judgment, under which the Dutch government was ordered to make deeper cuts to emissions by the end of 2020. The Urgenda judgment was based on interpretation of the non-investment obligations that the Dutch government had assumed under two different international treaties – the European Convention on Human Rights (“ECHR”) and the Paris Agreement. The Netherlands is therefore likely to use these non-investment obligations and the Urgenda judgment in defence of its phase-out policy.
Following the approach in S.D. Myers, the tribunal in the RWE case may look at the motivations of the Dutch government in adopting its phase-out policy. If so, as long as the policy was adopted in good faith and is applied in a non-discriminatory manner, the Dutch government’s climate obligations under the ECHR and the Paris Agreement as interpreted in Urgenda may not surrender to investment protections under the ECT. At the same time, the Netherlands’ non-investment obligations under the ECHR predate the government’s investment obligations under the ECT by some four decades, allowing for the State’s human rights obligations to influence the interpretation of the ECT investment protections pursuant to SPP v Egypt. Finally, whether or not the “fair expectations conflict rule” adopted in Tecmed would also side with the Dutch depends largely on the political situation and scientific knowledge available at the time RWE had made its investment in the Dutch coal sector. Even if the above cases suggest that the tribunal in the RWE case may well take into account the Dutch government’s non-investment obligations in making its decision, the question as to how these will be used remains unanswered.
Conflict of norms in international arbitration – a complementary friend in the fight against climate change?
The radical approach of one norm prevailing in its entirety over another may not be adequate, or indeed desirable, in these cases. ISDS cases, whether or not climate-related, rarely try to reverse government policy. Rather, investors seek to obtain financial compensation for the detrimental impact of a particular policy on their investment. The pertinent question, then, is one of risk allocation – who bears the risk of financial detriment caused by climate policy? As demonstrated above, several conflict rules established in case law would allow tribunals to consider non-investment obligations in ongoing climate-related ISDS cases. As these disputes are primarily focused on the level of compensation, the relevant non-investment norms may be most useful in adjusting the compensation claimed to meet the real value lost, taking into account the fact that the State was obligated to enact a particular policy and that the investment in question may have been phased out by, for example, market forces, in any case. Such an interpretative approach would introduce a concept of risk sharing, in which all stakeholders in the investment assume the risk of the investment becoming undesirable further down the line. In this way, the conflict of norms in international investment arbitration can become a complementary friend in the fight against climate change, with non-investment norms compensating for certain outdated features of investment norms while allowing fundamental investment protections to persist in a decarbonised world.
Zaneta Sedilekova is an Associate at Clyde & Co, at the firm’s climate risk and reinsurance team. She has co-authored a report on climate change risk and the future of legal profession for The Law Society and has been an active member of the community of lawyers drafting climate-conscious contractual clause with The Chancery Lane Project. Her practice involves arbitrating reinsurance disputes and advising on issues of climate change risk within the wider financial sector.
Josh van den Dries is a qualified solicitor in England and Wales and a Project Associate at The Chancery Lane Project (TCLP). As part of the TCLP team, Josh has worked on the Net Zero Toolkit, a set of practical tools and guidance enabling lawyers to draft climate-conscious contracts to align their work with a decarbonised economy and a safe and habitable planet. Josh is also responsible for editing, maintaining and updating TCLP’s database of climate clauses.