Investment In The Energy Sector Law International Essay

Published Date: 02 Nov 2017

CONTENTS

Introduction

1.1 Overview

Energy resources are the driving force of the economic development, although their ownership most often lies in the hands of states. The world's confirmed reserves of oil and gas have increased since 1980, at an average annual rate of 2.4% and 3.4% respectively. [1] More than half of the oil reserves are concentrated in the Middle East, while over 60% of the world's gas reserves are in the fields located in Russia and the Middle East. Over 80% of the coal deposits are found in six countries, amongst which are the United States (27.6%), Russia (18.2%), and China (13.3%). In spite of the increase in the reserves of oil and gas, the global production in 2009 registered record drops, and slightly redressed in 2010 but without matching the growth in consumption.

The limited nature of energy resources triggers significant trade that transcends national borders. By essence, the uneven distribution of oil, gas and coal supplies generates a range of worldwide relations that are complex and challenging; from exploration to production, distribution and consumption and other related activities without which the energy products would not reach their final destination. [2] Energy economy is no longer limited to the making of profit; environmental issues, for example, became the concern of the major players in the field, for energy companies and regulators alike. [3] Energy is going beyond conventional resources and expanding towards clean and renewable sources, such as wind and sunlight.

Energy investments distinguish themselves from other forms of investment essentially by their large size and the lengthy period between the initial commitment and the first returns. Energy investments concerning exploration and development must materialize where resources are located, be it inland or offshore. States, usually through their national companies, play an important role in energy investments since they have the ownership rights over energy-related resources. [4] The sovereignty over natural resources places states in a comfortable position, as it is the state that decides the energy policies and the resources that can be shared with foreign investors. [5] The risk associated with energy investments is significant given the size of the commitments and the duration of investments. The life span of energy investments often forces the modification of the terms of the agreements between investors and governments.

Investors in the energy field range from small to large companies. Natural persons usually emerge as shareholders in these companies and rarely become visible in energy transactions. The energy sector is still dominated by major players, [6] multinational or international private companies, such as British Petroleum, ExxonMobil, EDF and E.ON, and national companies, for example, Petrobras (Brazil), Gazprom (Russia) and Pemex (Mexico). The last decades of fluctuating prices for barrel of oil triggered some surprising mergers and market adjustments, for instance, the BP and Amoco merger of 1998 and the Exxon and Mobil merger of 1999.

1.2 Hypothesis

The substantive protection of investments, ranging from fair and equitable treatment standard to protection against unlawful expropriation, along with the procedural protection granted to investors and their investments are intended to strengthen the legal framework in which investments are made, and enhance transparency and stability. An attempt is made to analyze the safeguards provided by Energy Charter Treaty (hereinafter ‘ECT’) for investments in the energy sector. Negotiated between July, 1991, and December, 1994, the ECT is the only multilateral document for the protection of investments in the energy field that succeeded in being negotiated, signed and entered into force in such a short period. [7] It is sometimes referred to as a ‘free trade agreement’, or as a ‘post-Cold War miracle’.

38% of the cases submitted to the ICSID concern energy-related disputes, [8] while 4% of them are relying on the provisions of the Energy Charter Treaty (ECT). During the earlier periods energy disputes between states and energy investors were primarily concerned direct expropriation claims. However, nowadays, the cases brought under treaties for the protection and promotion of investments also rely on indirect expropriations through regulatory or administrative policies, such as the setting of tariffs or granting of licenses. [9] 

1.3 Research Methodology

The project is based on the question of investment in Energy sector. Hence, a Doctrinal study has been conducted. In furtherance of the completion of this article, the researcher has made extensive use of the facilities (inclusive of books, article and other relevant academic material available on the internet) available on Investment and the Energy Sector in the NALSAR Library, Hyderabad. Internet facilities have been used, which include Jstor, HeinOnline, Google etc.

1.4 Scope & Limitation

Privatization has been carried out in many avenues of Aviation Industry. However, the reason for narrowing down the scope of research to Delhi & Mumbai Airports has primarily been due to them being Brownfield International Airports. These airports handle the maximum air traffic in India and were in desperate need of overhaul before their privatization. Despite their massive upgradation, they are again fast approaching their saturation.

The other International Airports which are under the PPP model are Green Field projects and have been built afresh. They have substantial partnership with their respective state governments.

The airport projects being analyzed by the researcher have been rife with controversies ranging from the evaluation of the tender which was challenged by a losing bidder (Reliance Consortium) to Public outcry over High User Charges. These projects also mark the start of the privatization in Airport Segment in India and are thus, the ones from which maximum lessons can be learnt. They offer a set of unforeseen diverse problems which need to be legally addressed to avoid future hiccups in privatization.

1.5 Chapter Segregation

The Second Chapter introduces PPP models existing in India in the Infrastructure Sector as well as the permissible FDI limits. It then states the incentives offered to a private party in a PPP project and the different types of PPP models. The procedure for getting approval from government for PPP projects for airports has also been discussed.

The Third Chapter gives an overview of the regulatory authorities and their respective jurisdictions. The working of Airport Authority of India is discussed in detail as well as the classification of airports.

The Fourth Chapter deals with legal problems in privatization of airports such as the fate of existing commercial contracts, retrenchment of work force, Land Acquisition, Insurance, Environment and Government Control.

The Fifth Chapter deals with privatization of Delh & Mumbai airports. The whole procedure from the beginning is explained, the conditions discussed and other rights are mentioned.

The Sixth chapter deals with Airport Charges and their regulation by AERA. It discusses the hiccups including the CAG report of fee hike.

Energy Charter Treaty

Disputes involving Investments in Energy Sector

It is evident that there has been an increase in the number of disputes between investors and states related to actions and omissions of states. Disputes involving energy companies are numerous and submitted for resolution to various venues, from mediation to domestic and international courts and commercial and investment arbitration. They are based on various binding instruments, from agreements between governments and private companies to bilateral and multilateral treaties.

In 1950, the International Court of Justice (hereinafter ‘ICJ’) dismissed the case between the United Kingdom and Iran concerning the termination of petroleum concessions in Iran of the Anglo-Iranian Oil Company for lack of jurisdiction. [10] 

In the Lena Goldfields Case of 1930, [11] the arbitral tribunal held the Soviet government liable to pay over GBP 8 million to Lena Goldfields Ltd, a British corporation, which was granted a concession with the exclusive right to mine gold and other minerals in the Ural Mountains and parts of Siberia.

The energy disputes in Aramco [12] and Sapphire [13] cases were both submitted to arbitration and remain notorious for the stabilization clauses contained in the concession agreement and in the petroleum agreement, respectively.

In 1971, the Government of Libya enacted a decree that nationalized the interests and properties in Libya of BP Exploration Company Ltd, and in 1973 continued applying these measures to other international oil companies in Libya. As a result of this policy, three arbitration proceedings had been initiated against Libya: by BP Exploration Company (BP Case), [14] Texaco Overseas Petroleum and California Asiatic Oil Company (Texaco Case), [15] and the third arbitration by the Libyan American Oil Company (LIAMCO Case) [16] .

Also important is the Aminoil Case, [17] where the dispute concerned a 60 year concession contract between the government of Kuwait and the American Independent Oil Company.

With the growing number of investment treaties, [18] investors in the energy field began to look for alternative venues to national courts and commercial arbitration. The International Centre for Settlement of Investment Disputes (ICSID), created by the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention), [19] received more than 350 disputes based on BITs and other treaties offering protection to investors and their investments, or on the domestic law of the host state or on contracts between the disputing parties. [20] 

Inception of the Treaty

Natural resources-related investments have always been a sensitive field with particular consequences: from exploitation to intervention measures, to ownership rights and exhaustibility, regulation and excessive risks. Foreign investors in these sectors have been particular targets of nationalistic actions on the part of host authorities.

The boom in bilateral investment treaties and trade agreements for the protection and promotion of investments brought visibility and complexity to investor-state disputes. These instruments made a significant contribution to the development and implementation of an economic and legal framework for the promotion and safeguard of investors and investments. They also played an important part in and improved the access for investors to dispute resolution mechanisms, particularly arbitration, for the protection of their investments.

In this vast network of treaties and agreements aspiring to offer investors proper conditions for a stable and predictable investment environment, the Energy Charter Treaty (hereinafter ‘ECT’) stands out as a unique multilateral treaty aimed at facilitating transactions and investments in the energy field.

The repositioning of the national economies after the fall of the communist regimes in Eurasia in 1989–1991 brought significant changes in the distribution of natural resources and economic wealth, along with the entrance of new players and the opening of investment opportunities.

For the Eastern European states and the former Soviet countries, the freedom from the communist regime came with political and civil unrest and economic decline. Their industries and, in particular, the energy sector, encountered problems in performance, with outdated technologies and products, and capital shortages.

The dissolution of the Soviet Union in 1991 and the independence of the former Soviet republics increased the investment prospects for Western investors. However, this came along with a high investment risk, triggered by excessive bureaucracy, uncertainties in policies and procedures, inadequate infrastructure, political instability etc.

At the same time, the Western European states were going through unprecedented energy crisis. The security supply was the main concern of the Member States of the EU, with consumption exceeding production with over 50% in 1990 and amounting to 12.5% of the world energy consumption. [21] The Western European states foresaw the potential of the opening up of the former Soviet Union energy market and envisaged their role in securing the necessary energy resources and reducing their reliance on the OPEC supplies.

Thus, the ECT came to life soon after the fall of the communist regimes across Europe and the dissolution of the Soviet Union, and it was motivated by the desire of the Western European states to secure their access to the much needed natural resources of the Eastern countries.

The ECT is a complex multilateral treaty with its scope limited to the energy sector. The treaty was born out of the need to find a mutually accepted foundation for energy cooperation between Western European countries and countries of the former Soviet Union and Eastern Europe. It represents an attempt to commit countries which used to have a centralized and planned economy to a model of market oriented, and liberal, economic policy with respect to investment, trade and transit in the energy sector. Its goal is to fully protect foreign investments and to prevent discrimination in favour of national business.

The Energy Charter Treaty as well as the Energy Charter Protocol on Energy Efficiency and Related Environmental Aspects were signed in December 1994 and entered into force in 1998. The first arbitral award under the ECT was rendered on 16th December, 2003, by an arbitral tribunal sitting in Stockholm. Subsequently numerous others have followed addressing procedural as well as substantive issues. The awards despite increasing in length are not necessarily clearer and are not always consistent. Since ECT arbitral awards are rendered within the framework of public international law, there is no system of binding precedent. This means that it will take a long time for the arbitral case law to bring order to the interpretation and understanding of the ECT.

Membership

Major producers of energy have not signed or ratified the ECT, while major consumers of energy are regarding the ECT in a favourable light. The ECT is sometimes viewed as a club for rich countries, as no African, Asian or Latin American states are part of it. This situation is frequently blamed on the demanding conditions for the accession to the ECT. Up to date, the following states and Regional Economic Integration Organizations consented to be bound by the ECT: [22] 

Contracting Parties to the ECT: [23] Albania, Armenia, Austria, Azerbaijan, Belgium, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Denmark, Estonia, the European Communities, Finland, France, Georgia, Germany, Greece, Hungary, Ireland, Italy, Japan, Kazakhstan, Kyrgyzstan, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Moldova, Mongolia, the Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, Switzerland, Tajikistan, the Former Yugoslav Republic of Macedonia, Turkey, Turkmenistan, Ukraine, United Kingdom and Uzbekistan.

Signatories of the ECT: Australia, Belarus, Iceland, Norway.

The status of Contracting Party to the ECT should not be mistaken for the membership or observership. The members of the Energy Charter Process are either signatories or Contracting Parties to the ECT. Observership is considered to be ‘a "light" form of participation in the Charter Process’ and may be a transitional step towards full membership. There are two categories of observers:

Observers who have signed the European Charter: Afghanistan, Canada, Indonesia, Jordan, Pakistan, Serbia, Syria, United States; and

Observers who have not signed the European Charter: Algeria, Bahrain, China, Egypt, Iran, Korea, Kuwait, Morocco, Nigeria, Oman, Palestinian National Authority, Qatar, Saudi Arabia, Tunisia, United Arab Emirates, Venezuela, the Association of Southeast Asian Nations (ASEAN) and the Baltic Sea Region Energy Co-Operation (BASREC), the Black Sea Economic Cooperation (BSEC), the CIS Electric Power Council, the European Bank for Reconstruction and Development (EBRD), the IEA, the OECD, the UN Economic Commission for Europe (UN-ECE), the World Bank, the World Trade Organization (WTO).

Object & Scope of ECT

The scope of the ECT is not to regulate in detail all issues concerning the energy field, but to provide a ‘framework based on which the Contracting Parties can further negotiate various sets of rules applicable in the energy area’ [24] .

The purpose of the ECT is to establish ‘a legal framework in order to promote long-term co-operation in the energy field, based on complementarities and mutual benefits, in accordance with the objectives and principles of the Charter’ [25] .

The Preamble states the aim of the drafters to ‘catalyse economic growth by means of measures to liberalize investment and trade in energy’. [26] Besides the provisions in the Preamble and the 8 Parts, totaling 50 articles, the ECT includes a number of other instruments that are part of the ECT. There are 14 annexes and 5 decisions with respect to the ECT, [27] 22 understandings, [28] 7 declarations of the signatories. [29] The ECT is also supplemented by the Energy Charter Protocol on Energy Efficiency and Related Environmental Aspects, [30] and amended by the Trade Amendment. [31] 

The ECT is limited in application to the energy field and it is structured on three main pillars: trade, transit and investment, but also contains important provisions on competition, transfer of technology, access to capital, environmental protection, energy efficiency and taxation in the energy field. The trade-related provisions of the ECT are aimed to assist economies in transition towards membership of the WTO system.

The transit provisions underline the necessity for each Contracting Party to take the appropriate measures to facilitate transit in accordance with the principle of freedom of transit and without distinction as to the origin, destination, ownership or pricing, and without imposing unreasonable delays, restrictions and charges. Probably the most important feature of the ECT lies in its provisions on the promotion and protection of Investments under Part III. The ECT also provides for the resolution of disputes between Investors and Contracting Parties concerning alleged breaches of the obligations for the promotion and protection of Investments by the Contracting Parties.

The role of the ECT is to facilitate transactions and investments in the energy field by reducing political and regulatory risks, as a natural response to the increasing globalization of the economy. It provides for comprehensive provisions for the promotion and protection of Investors and their Investments in the energy field. Nevertheless, the short negotiation period of the ECT and the conflicting interests of the negotiating parties required some concessions to be made.

Protection and Dispute Resolution

The obligations of the Contracting Parties to promote and protect Investments of Investors are found in Part III of the ECT. Under these provisions, Contracting Parties shall commit to accord at all times to Investments of Investors of other Contracting Parties fair and equitable treatment and most constant protection and security; shall not in any way impair by unreasonable measures the management, maintenance, use, enjoyment or disposal of such Investments; [32] and shall accord to Investments and their related activities treatment no less favourable than that which it accords to Investments of own Investors or of the Investors of any other Contracting Party or third state, whichever is the most favourable.

Article 12 of the ECT provides for the compensation of Investors for losses caused by war or other armed conflict, state of national emergency, civil disturbance or other similar event in the Area of a Contracting Party.

Pursuant to Article 13 of the ECT, Investments shall not be unlawfully nationalized, expropriated or subjected to measures having effect equivalent to nationalization or expropriation. Under Article 14 the Contracting Parties guarantee the freedom of transfer of funds, without delay and in free convertible currency.

The ECT is not a self-contained treaty. The disputes between Investors and Contracting Parties concerning alleged breaches of the obligations for the promotion and protection of Investments must be submitted to institutions or structures outside the ECT. The treaty obligations are enforceable against the Contracting Parties under the procedural remedies provided for in Article 26 of the ECT. This entails that firstly, an attempt be made to settle the dispute amicably. Upon failure to settle amicably, by a notice of 3 months to resolve to the dispute via (a) courts or administrative tribunals of the Contracting party to the dispute; [33] or (b) in accordance with any applicable, previously agreed dispute settlement procedure; [34] or (c) International Centre for Settlement of Investment Disputes, established pursuant to the Convention on the Settlement of Investment Disputes between States and Nationals of other States (hereinafter ‘ICSID Convention’); [35] or sole arbitrator or ad hoc arbitration tribunal established under the Arbitration Rules of the UN Commission on International Trade Law (hereinafter ‘UNCITRAL’); [36] or an arbitral proceeding under the Arbitration Institute of the Stockholm Chamber of Commerce. [37] 

An Investor of a Contracting Party to the ECT that chooses to submit to ICSID his dispute against another Contracting Party must observe a two-fold test: the Contracting Party of the Investor as well as the respondent Contracting Party must be Contracting States of the ICSID Convention. [38] Out of the 47 Contracting Parties of the ECT, four are not Contracting States of the ICSID Convention: Kyrgyzstan, [39] Lichtenstein, Poland and Tajikistan.

Article 2(1) of the ICSID Additional Facility Rules provides for three circumstances in which the Rules are applicable:

When a legal dispute arising directly out of an investment is not within the jurisdiction of the ICSID because ‘either the State party to the dispute or the State whose national is a party to the dispute is not a Contracting State’.

Where either the state of the investor or the respondent state or both states are Contracting States of the ICSID Convention, but the investment requirement of the ICSID Convention is not met.

Fact-finding proceedings.

The concepts of signatories or contracting parties are unknown for the UNCITRAL Rules and the SCC Rules. Investors that wish to submit their claims against Contracting Parties to the ECT with the SCC or under the UNCITRAL Rules will have to make sure that they fulfill only the requirements of the ECT. No additional hurdles are imposed under these arbitration options, which make SCC and UNCITRAL safe alternatives to the rigorous conditions of the ICSID Convention and the ICSID Additional Facility Rules.

The notion of ‘Investor’ within the ECT framework and its related treaties and arbitration rules is essential for the substantive and procedural protection of Investors and their Investments. Although the ECT provides for a definition of Investor, the notion of ‘Investor’ goes beyond this definition: it is shaped not only by the provisions of the ECT, but also by the related treaties and rules under the Investor-Contracting Party dispute resolution mechanism. It is also fundamental for the understanding of the notion of ‘Investor’ to consider it as it naturally interacts with the concepts of ‘Contracting Party’ and ‘Investment’. The notion of ‘Investor’ has two essential characteristics: it is challenging to assign it with a precise definition – any attempt to define this notion will not comprehensively encompass all its features; and it is a flexible notion, tailored to suit the treaties and rules interacting with the ECT. The intrinsic complexity of the notion of ‘Investor’ is amplified by web of provisions of the ECT, not always comprehensible and straightforward. The speed of the ECT's negotiation was not only the determinant factor that contributed to the entry into force of the ECT, but also led to a compromise treaty. In this context, it is essential that a proper analysis of the notion of ‘Investor’ be made in the light of the rules of treaty interpretation of the Vienna Convention on the Law of Treaties.

Investor & Contracting party under the ECT

Investor

The notion of ‘Investor’ is essential for both substantive and procedural protections granted by the ECT. Only Investors within the meaning of the ECT may claim protection of their Investments in accordance with Part III of the ECT, and only these Investors have access to the remedies offered by the ECT in case of breaches by Contracting Parties of their obligations to protect these Investments of Investors. The definition of Investor under Article 1(7)(a) of the ECT refers to:

a natural person having the citizenship or nationality of or who is permanently residing in that Contracting Party in accordance with its applicable law;

a company or other organization organized in accordance with the law applicable in that Contracting Party.

The term ‘Investor’ concerns natural persons and legal entities and it essentially connects Investors to the Contracting Parties to the ECT. Nationality is not the only bond between an Investor and a Contracting Party accepted by the ECT. Permanent residents can also avail themselves of the protection of the ECT. Similarly, not only companies may qualify as Investors under the ECT, but also any other organization organized in accordance with the laws of a Contracting Party to the ECT.

The jurisdiction over a dispute between an Investor and a Contracting Party concerning alleged breaches of the obligations of the latter under Part III of the ECT exists when personal jurisdiction (ratione personae), i.e. the existence of an Investor, and the material jurisdiction (ratione materiae), i.e. an Investment in the Area of the respondent Contracting Party coexist. A strong case of unlawful expropriation, for example, may collapse at the jurisdictional stage in the absence of these two key elements.

Interpreting the Contracting Party

The analysis of the notion of ‘Investor’ commences with the concept of ‘Contracting Party’ to the ECT. The analysis is thus limited to the notion of ‘Contracting Party’ as this is connected with the status of Investor under the ECT. Investor is essentially connected to a Contracting Party, and from this point of view, the clarification of the notion of ‘Contracting Party’ to the ECT is required.

As the procedural remedies are not accomplished by the ECT alone, but together with related treaties and arbitration rules, the notions of ‘Investor’, ‘Contracting Party’ and ‘Investment’ must be clarified not only within the meaning of the ECT, but also with a view of the interplay between the ECT and related treaties and rules [40] . For the substantive protection of the ECT, the interaction with these treaties and rules presents little relevance; however, for the enforcement of Investor's rights under the provisions for the protection of Investments, Investors must observe the limitations imposed by these instruments. At the same time, the relationship between the ECT and the related treaties and rules is relevant for arbitral tribunals constituted under Article 26 of the ECT. These tribunals must have competence under both the ECT and the relevant treaty or arbitration rules. In the ECT case of Kardassopoulos v. Georgia, [41] the arbitral tribunal concluded that:

In order for the Tribunal to have jurisdiction ratione materiae over the present dispute, it must be found to have jurisdiction under the ICSID Convention, and under the ECT …

The ECT is an international treaty and the analysis of the notion of ‘Investor’ has to be made in accordance with the rules of treaty interpretation laid down in Article 31 and 32 of the Vienna Convention on the Law of Treaties (hereinafter ‘Vienna Convention’). [42] Several Contracting Parties to the ECT – for example, Azerbaijan, France and Romania – are not parties to the Vienna Convention, and, thus, the Convention is not directly applicable to them. However, the rules of treaty interpretation of the Vienna Convention are recognized as codifying the existing customary international law and, therefore, applicable to the interpretation of the provisions of the ECT.

Vienna Convention on the Law of Treaties between States and International Organizations or between International Organizations, restates the rules of treaty interpretation under the Vienna Convention and is relevant in the context of the ECT. It was opened for signature on 21st March, 1986, but has not yet entered into force. [43] 

The Contracting Party

Traditionally, contracting parties to treaties are states that possess an inherent capacity to conclude these binding instruments, but entities, other than states, may also participate. With respect to the ECT, states and Regional Economic Integration Organizations (REIOs) may be bound by the provisions of the ECT.

Under Article 1(2) of the ECT, a Contracting Party is defined as ‘a state or Regional Economic Integration Organization which has consented to be bound by this Treaty and for which the Treaty is in force.’ The definition provides for two cumulative conditions: the consent to be bound by and the entry into force of the ECT.

Article 1(3) of the ECT defines REIO as ‘an organization constituted by states to which they have transferred competence over certain matters a number of which are governed by this Treaty, including the authority to take decisions binding on them in respect of those matters.’

Upon withdrawal from the ECT, the status of Contracting Party to the ECT ceases to exist. Under Article 47 of the ECT, any Contracting Party may request the withdrawal from the ECT and such withdrawal takes effect upon the expiry of one year after the date of the receipt of the notification of withdrawal or after a later period specified in the notification. [44] 

The ECT is applicable for a period of 20 years to Investments made by Investors of the denouncing Contracting Party in the Areas of other Contracting Parties and to Investments made by Investors of other Contracting Parties in the Area of the denouncing Contracting Party. [45] This means that the ECT continues to apply, but only to Investments made before the withdrawal takes effect, i.e. one year after the date of notification or a later period, if specified in the notification. Consequently, Investors may avail themselves of the provisions of the ECT for a period of 20 years.

Nationality, citizenship, permanent residence, incorporation or organisation in accordance with the laws of a Contracting Party to the ECT is key elements which establish the link between a Contracting Party and a natural person or a legal entity claiming the status of Investor.

For natural persons, Article 1(7)(a)(i) provides that they must have the citizenship or nationality of or reside permanently in a Contracting Party in accordance with its applicable law. [46] For legal entities, Article 1(7)(a)(ii) briefly refers to ‘a company or other organization organized in accordance with the law applicable in that Contracting Party’.

Undoubtedly, the majority of investments are channeled through legal entities, and corporations mostly appear as claimant in investment arbitration cases. Only two of the disputes submitted to arbitration under Article 26 of the ECT were initiated by natural persons. [47] 

One essential prerequisite for investors to gain access to the protection of investment treaties and, ultimately, to resort to arbitration in the event of a dispute with the host state of the investment, is to hold the nationality of a foreign state or, in some cases, to permanently reside in that foreign state. The challenges of the globalized society, the complexity of the corporate structures through which investments are channelled and the reality that one person possesses more than one nationality or permanently lives in a state other than his state of nationality, brings novel hurdles in assessing nationality of investors.

Nationality remains one of the debatable concepts of law that has no universally agreed definition. In investment law, the investor's nationality, or in some cases his residence in a state, is one of the elements ensuring the access to the protection granted by investment treaties and it also determines the competence of tribunals with respect to the dispute. Where an investor is seeking protection from investment instruments, he must comply with the nationality or other requirements set forth therein. However, these treaties do not provide for a definition of nationality, but they offer guidance in assessing the nationality of investors, usually by reference to the laws of the contracting parties.

In order to gain access to the protection of the ECT and to be able to bring a dispute against the Contracting Party hosting their Investments, natural persons must meet certain prerequisites. Article 1(7) of the ECT provides that natural persons may qualify as Investors if they have ‘the citizenship or nationality of or [are] permanently residing in that Contracting Party in accordance with its applicable law’. Article 1(7) of the ECT employs three notions for designating the link between natural persons and Contracting Parties for the purpose of the notion of ‘Investor’: nationality, citizenship and permanent residence. The ECT, however, does not provide for a definition of these notions.

Nationality: The language of the ECT is unambiguous as to the assessment of natural persons' nationality. Article 1(7) of the ECT requires only for nationality of individuals to be in accordance with the laws of the Contracting Parties.

Citizenship: Some states refer to either nationality or citizenship to designate their legal relationship with an individual, while some states use both terms. An important difference is that while the term ‘nationality’ is used for natural persons and legal entities, the term ‘citizenship’ refers to natural persons only. In this context, perhaps the ECT drafters preferred to use both terms in Article 1(7) in order to reconcile the different approaches taken by the laws of the Contracting Parties.

Permanent Residents: In order to be covered by the provisions of Article 1(7) of the ECT, individuals must be permanent residents in accordance with the law of a Contracting Party to the ECT.

Company

Under the rules of customary international law, the ICJ, in the landmark case of Barcelona Traction, recognized the test of incorporation together with the seat theory:

In allocating corporate entities to States for purposes of diplomatic protection, international law is based, but only to a limited extent, on an analogy with the rules governing the nationality of individuals. The traditional rule attributes the right of diplomatic protection of a corporate entity to the State under the laws of which it is incorporated and in whose territory it has its registered office. These two criteria have been confirmed by long practice and by numerous international instruments.

Article 1(7) of the ECT retains the test of incorporation for determining the nationality of a company, and, consequently, its access to the protection of the ECT. The test of incorporation indicates that the company is viewed as possessing the nationality of the state of incorporation and the laws of this state are governing the company. The law of the place of incorporation does not only determine the nationality of the company, but it also regulates issues related to the legal personality of the company, its management, the relations between shareholders, between shareholders and the company etc.

Investors of a Contracting Party Controlled by Investors of another Contracting Party

Investors are frequently required to carry out their investments through locally incorporated companies. This can be a condition imposed by the host state,(167) or a convenient option for structuring the investment.(168) Where the nationality of the company is determined by the place of incorporation, the locally incorporated company will be considered a national of the host state, unless adopting the control test for determining the actual nationality.(169) This would be the case under the ECT, as the competence of ECT tribunals extends only to disputes between a Contracting Party and Investors of another Contracting Party.(170) Such treatment, nevertheless, would be inequitable, in particular for Investors forced to channel their investments through local companies, and would deny access to the investment protection of the ECT to a large number of Investors.

Article 26(7) of the ECT contains the agreement of the Contracting Parties to treat a legal entity, ‘which has the nationality of a Contracting Party party to the dispute on the date of the consent in writing … and which, before a dispute between it and that Contracting Party arises, is controlled by Investors of another Contracting Party’, as a national of another Contracting State, for the purpose of Article 25(2)(b) of the ICSID Convention.(186) This provision allows the control test to be applied in determining the nationality of a legal entity in the context of an arbitration submitted under the ICSID Convention, in addition to the incorporation test in Article 1(7) of the ECT. Consequently, legal entities that would normally be treated as nationals of the host Contracting Party and, thus, barred from bringing a dispute against this Contracting Party under Article 26 of the ECT, are allowed to do so if they are controlled by Investors of another Contracting Party.

Under the ICSID Convention, this situation is covered by Article 25(2)(b), which provides that:

any juridical person which had the nationality of a Contracting State other than the State party to the dispute on the date on which the parties consented to submit such dispute to conciliation or arbitration and any juridical person which had the nationality of the Contracting State party to the dispute on that date and which, because of foreign control, the parties have agreed should be treated as a national of another Contracting State for the purposes of this Convention.(171)

Pursuant to this provision, a juridical person is treated as a national of another Contracting State because of the foreign control.(172) Nevertheless, Article 25(2)(b) stresses that the parties must have agreed to treat the juridical person as a national of another Contracting State.(173)

Article 26(7) of the ECT does not provide for an explanation of ‘foreign control’. The provisions of the Understanding No. 3 of the Final Act clarify the notion of ‘control’ in the context of the definition of ‘Investment’ in Article 1(6) of the ECT.(187) The explanation of ‘control’ in Understanding No. 3 suggests that the notion of ‘control’ has an objective meaning.(188) The test for determining the existence of control may be quantitative, where investors own a certain percentage of the shares, or qualitative, underlined by the ability of investors to decisively influence the management of investments. The ECT does not explicitly adopt one of these tests, and this rather suggests that any kind of control qualifies for the purpose of Article 26(7).

Article 26(7) of the ECT does not restrict the foreign control to a single controller. It can be the case where the arbitral tribunal's inquiry reveals that the foreign control is equally exercised by two or more foreign nationals. As long as the nationals are of Contracting Parties to the ECT, there is nothing to prevent arbitral tribunal to uphold the applicability of Article 26(7) of the ECT.

The existence of foreign control leads to the piercing of the corporate veil in order to find the actual controllers of the company. Article 26(7) of the ECT does not offer guidance as to how tribunals should proceed in discovering the ‘foreign control’ of the locally incorporated company.(201)

The definition of ‘Investment’ under the ECT is broad and covers ‘every kind of asset, owned or controlled directly or indirectly by an Investor and includes … a company or business enterprise, or shares, stock or other forms of equity participation in a company or business enterprise’.(255) Understanding No. 3 of the Final Act explains that the notion of ‘control’ under Article 1(6) of the ECT refers to ‘control in fact, determined after an examination of the actual circumstances in each situation’.(256) The ECT, therefore, not only recognizes as an Investment the ownership or control of a company or enterprise, but also the ownership or control of shares, stock or other forms of equity participation in a company or enterprise. Ownership and control can be either direct or indirect.(257)

The ECT places no restriction on the number of shares to be owned or controlled by an Investor.(258) This allows minority shareholding to qualify as an Investment for the purpose of Article 1(6) of the ECT.

The permissive language of Article 1(7) of the ECT,(281) and the absence of an explicit exclusion of state owned or controlled companies from the definition of investor suggest that such entities may benefit from the protection of the ECT.(282)

Denial of Benefits clause in ECT

The broad definition of ‘Investor’ in Article 1(7) of the ECT is balanced by the provisions of Article 17 of the ECT, which restricts the benefits of the provisions concerning the promotion and protection of Investments to certain categories of legal entities or Investments of Investors under the so-called denial of benefits clause. Article 17 of the ECT provides for the following:

Each Contracting Party reserves the right to deny the advantages of this Part to:

a legal entity if citizens or nationals of a third state own or control such entity and if that entity has no substantial business activities in the Area of the Contracting Party in which it is organized; or

an Investment, if the denying Contracting Party establishes that such Investment is an Investment of an Investor of a third state with or as to which the denying Contracting Party:

does not maintain a diplomatic relationship; or

adopts or maintains measures that:

prohibit transactions with Investors of that state; or

would be violated or circumvented if the benefits of this Part were accorded to Investors of that state or to their Investments.

The denial of benefits clause is often seen as a safeguard against free riders, or as a method to counteract nationality planning, or to preserve reciprocity in the relationship between two states. Irrespective of what it is called, the purpose of the clause is to exclude from the protection offered by treaties investors or investments that, under normal circumstances, would not benefit from host state's protection.

The right conferred on Contracting Parties by Article 17 of the ECT is in line with clauses found in modern bilateral and multilateral investment and trade treaties. [48] 

Article 17 of the ECT denies legal entities and Investments the right to benefit from the provisions on the promotion and protection of Investments. However, as the denial of benefits clause limits the benefits of investment protection to a class of Investors and Investments, the analysis of this provision is relevant in the context of the notion of ‘Investor’.

Article 17 denies the benefits included in Part III of the ECT, which refers to the protection and promotion of Investments. Additionally, the title of Article 17 is restricted to ‘Non-application of Part III in certain circumstances’. The wording of the denial of benefits clause suggests that other rights provided to Investors and not covered in Part III of the ECT, for example the dispute resolution rights under Article 26 of Part V of the ECT, are not excluded by the application of the denial of benefits clause

Nevertheless, Article 17 of the ECT must be read in the light of the provisions of Article 26(1) of the ECT that is restricted to disputes ‘which concern an alleged breach of an obligation … under Part III’. The substantive protection of Investors cannot be effective without the remedies contained in the dispute resolution mechanism under Article 26 of the ECT:

the Tribunal finds that the Treaty itself, together with so many other treaties of investment protection, has as a distinctive feature special dispute settlement mechanisms not normally open to investors. Access to these mechanisms is part of the protection offered under the Treaty. It is part of the treatment of foreign investors and investments.…(356)

Thus, Article 17 of the ECT denies not only the benefits of Part III, but also the procedural remedies under Part V of the ECT.

The exclusion of Article 26 of the ECT from the benefits denied by Article 17 has little practical consequences to the outcome of a dispute. By considering that Article 17 does not deny the right to resort to the dispute resolution mechanism under Article 26, tribunals are called to decide on the denial of benefits at the merits stage; alternatively, by interpreting the provisions of Article 17 with a view of the ECT as a whole and, thus, excluding the benefits of Part III and Article 26, tribunals would still have to decide whether they have competence to hear the case, based on the principle of competence-competence, and, therefore, ensure the access of Investors to the procedural protection of the ECT.

Application and Effects of the ‘Denial of Benefits’ Clause: Because of the way Investments are structured nowadays, Contracting Parties usually become aware of the circumstances justifying the application of Article 17 of the ECT only after Investor files the claim.(359)

The host State may not even be aware of the establishment of a new investment in its territory, let alone the nationality of that investor, the extent of its business activities in its home State, and the nationality of its underlying owners or controllers.… The host State may only learn of the conditions that would justify invoking its right to deny at such time as an investor notifies it that a dispute under the ECT has arisen and possibly not even then.

Article 17 provides that each Contracting Party ‘reserves the right to deny the advantages’ of Part III of the ECT. Several questions in connection with this introductory part of the denial of benefits clause have been raised in practice. They mainly concern the moment when a Contracting Party may invoke the denial of benefits right; whether there are special requirements for the exercise of this right; and the effects of the denial of benefits clause.

The wording of Article 17 suggests that the right to deny the benefits of Part III of the ECT to certain Investors or Investments must be exercised by a Contracting Party. A Contracting Party may choose to exercise this right or not.(361) The tribunal in Plama v. Bulgaria explained this as follows:

In the Tribunal's view, the existence of a ‘right’ is distinct from the exercise of that right. For example, a party may have a contractual right to refer a claim to arbitration; but there can be no arbitration unless and until that right is exercised. In the same way, a Contracting Party has a right under Article 17(1) ECT to deny a covered investor the advantages under Part III; but it is not required to exercise that right; and it may never do so. The language of Article 17(1) is unambiguous; and that meaning is consistent with the different state practices of the ECT's Contracting States under different bilateral investment treaties.…(362)

The same argument was noted by the Yukos tribunal:

Article 17(1) does not deny simpliciter the advantages of Part III of the ECT-as it easily could have been worded to do.… It rather ‘reserves the right’ of each Contracting Party to deny the advantages of that Part to such entity. This imports that, to effect denial, the Contracting Party must exercise the right.(363)

ECT tribunals were confronted with practical issues of the exercise of the denial of benefits right.(364) The main question concerned the manner in which the Contracting Parties should carry out such right. In Plama v. Bulgaria, the tribunal concluded that the denying Contracting Party must exercise the denial of benefits right in a public manner that must be reasonably made available to Investors:

The exercise would necessarily be associated with publicity or other notice so as to become reasonably available to investors and their advisers. To this end, a general declaration in a Contracting State's official gazette could suffice; or a statutory provision in a Contracting State's investment or other laws; or even an exchange of letters with a particular investor or class of investors.(365)

The Plama v. Bulgaria tribunal further explained that:

By itself, Article 17(1) ECT is at best only half a notice; without further reasonable notice of its exercise by the host state, its terms tell the investor little; and for all practical purposes, something more is needed.(366)

However, the conclusion of the Plama v. Bulgaria tribunal regarding the notice to be given to Investors is not based on the ordinary meaning of the terms of Article 17. Article 17 of the ECT does not provide for any requisites that should be complied with by the Contracting Party in denying the benefits of Part III to an ECT Investor.(367) Unlike Article 17 of the ECT, Article 1113 of the NAFTA expressly provides that the application of the denial of benefits clause is subject to prior notification and consultation where the legal entity is owned or controlled by nationals of a third state and has no substantial business in the Contracting Party where it is organized. The state denying the benefits of Chapter Eleven of the NAFTA must give prior notice to the state that the entity in question is asserting to be a national of, and consultations must be conducted in accordance with Article 2006 of the NAFTA. The commentators of the NAFTA see the consultation requirement as ‘a safeguard preventing a too-hasty decision on the real nationality of an enterprise by permitting the other Party to provide information about the alleged "sham" corporation…’.

However, the Plama v. Bulgaria tribunal saw in Article 1113 of the NAFTA the justification for an implied prior notice in the application of the denial of benefits clause under the ECT:

The Tribunal was referred to Article 1113(2) NAFTA as an example of a term providing for the denial of benefits which provides for a form of prior notification and consultation; and whilst the wording is materially different from Article 17(1) ECT, this term does suggest that the Tribunal's interpretation is not unreasonable as a practical matter.(370)

Such an implied requirement conflicts with the provisions of Article 31 of the Vienna Convention. The ordinary meaning of the terms used by Article 17 does not validate an implied requirement for a prior notification of investors by the Contracting Parties before exercising the denial of benefits right.(371) Scholars agree with this:

A natural and ordinary reading of the words in Article 17(1) yields no express or necessary condition that the denying State must first give prior notification for the denial of advantages to be effective.(372)

The plain wording of the introductory part of Article 17 of the ECT justifies the right of a Contracting Party to deny, at any time and without any formality, the advantages of Part III of the ECT.(373)

In Plama v. Bulgaria, the tribunal also found that when a Contracting Party exercises the right to deny the benefits of the promotion and protection of Investments, it could only do so with prospective effect. The tribunal rejected the retrospective effects of Article 17 of the ECT, relying on the legitimate expectations of Investors and on the purpose of the ECT:

The ECT's express ‘purpose’ under Article 2 ECT is the establishment of ‘…a legal framework in order to promote long-term co-operation in the energy field … in accordance with the objectives and principles of the Charter’(emphasis supplied). It is not easy to see how any retrospective effect is consistent with this ‘long-term’ purpose.(374)

The tribunal in the Yukos Cases concluded, in line with the decision of the Plama v. Bulgaria tribunal, that the application of the Article 17 of the ECT may only have prospective effects:

To treat denial as retrospective, would, in the light of the ECT's ‘Purpose, as set out in Article 2 of the Treaty … be incompatible ‘with the objectives and principles of the Charter.’ Paramount among those objectives and principles is ‘Promotion, Protection and Treatment of Investments’ as specified by the terms of Article 10 of the Treaty. Retrospective application of a denial of rights would be inconsistent with such promotion and protection and constitute treatment at odds with those terms.(375)

Article 2 provides that the purpose of the ECT is to develop a legal framework for the promotion of ‘long-term cooperation in the energy field’, which should be based on ‘complementarities and mutual benefits’. As the Amto v. Ukraine tribunal suggested, the denial of benefits clause is intended to strengthen long-term cooperation based on mutual benefits:

As the purpose of the ECT; is to establish a legal framework ‘in order to promote long-term cooperation in the energy field, based on complementarities and mutual benefits…’ then the potential exclusion of foreign owned entities from ECT investment protection under Article 17 is readily comprehensible.(376)

However, the tribunals in Plama v. Bulgaria and the Yukos Cases considered that to give retrospective effect to the denial of benefits clause would breach Investor's legitimate expectations and would contradict the object and purpose of the ECT. Nevertheless, the purpose of the ECT for the long-term cooperation in the energy field, based on mutual benefits, does not automatically exclude a retrospective refusal of benefits for Investors and Investments, which under normal circumstances would not be protected by the provisions of the ECT. Access to the protection granted by the ECT may only be based on reciprocal privileges and, as suggested by one author:

One could argue that the retrospective effect of Article 17(1) would benefit ‘long-term cooperation’ by encouraging investors to be upfront about ownership, nationality and citizenship.(377)

Article 17 of the ECT provides for the circumstances under which the benefits of Part III on the promotion and protection of Investments may be denied to legal entities and Investments. The clause is therefore not excluding Investors from the ECT's coverage, but it denies their access to some of the ECT's provisions. The right to deny the advantages offered by Part III of the ECT must be exercised by the denying Contracting Party. The issue of whether there is an implied requirement under Article 17 of the ECT to exercise the denial of benefits right by way of prior notification,(378) or whether the denial right has prospective or retrospective effect are issues still controversial in the practice of the ECT tribunals.

Denial of Benefits to a Legal Entity: The first situation dealt with by Article 17 of the ECT refers to the denial of benefits of Part III to a legal entity, if citizens or nationals of a third state own or control such entity and if that entity has no substantial business activities in the Area of the Contracting Party in which it is organized. Thus, Article 17(1) of the ECT sets forth two cumulative conditions for a Contracting Party to exercise its right to deny the benefits to promotion and protection of Investments:(a) the legal entity must be controlled or owned by citizens or nationals of a third state, and(b) the legal entity has no substantial business activity in the Contracting Party where it is organized. If one of the requisites provided by Article 17(1) of the ECT is not met, the denial of the benefits clause is inapplicable.(379)

a. Legal Entities Owned or Controlled by Nationals or Citizens of a Third State: Article 17(1) of the ECT excludes the benefits of Part III to legal entities when owned or controlled by ‘citizens or nationals of a third state’. Article 17(1) limits the ownership and control to nationals and citizens, and does not include permanent residents of third states.

The meaning of ‘third state’ in this context refers to a non-Contracting Party.(380) In the Yukos Cases, the tribunal had to interpret the reference to ‘third state’ under the first paragraph of the denial of benefits clause of the ECT. In doing so, the tribunal looked at several provision of the ECT that employ the wording ‘third state’ and reached the conclusion that the drafters of the ECT intended to refer to non-Contracting Parties:

several provisions distinguish between a Contracting Party and third State(for example, Articles(1)(7), 10(3) and 10(7), and 17) and that there is no equation in the ECT between a Contracting Party and a third State. This conclusion is further supported by the travaux préparatoires, which demonstrate that the term ‘third state’ was substituted for the term ‘non-Contracting Party.’(381)

The tribunal in Amto v. Ukraine concluded that ‘third state’ ‘is used in Article 1(7) in contradistinction to "Contracting Party", which suggests that a third state is any state that is not a Contracting Party to the ECT’.(382)

While ownership of a legal entity appea