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Germany’s Federal Constitutional Court takes aim at EU’s Legal Order

  • Legal Development 15 May 2020 15 May 2020
  • UK & Europe

  • Commercial Disputes

Germany's highest court, the Federal Constitutional Court (FCC) has, for a long-time now, shown scepticism towards the concept of absolute EU law supremacy and has reserved its right to review EU laws in certain circumstances. It has, however, been careful not to upset the EU legal order and had not acted on its threat – until now.

Germany’s Federal Constitutional Court takes aim at EU’s Legal Order

On 5 May 2020, the FCC handed down what has been reported as a "bombshell ruling". In its judgment, the FCC challenged the legality of the European Central Bank's (ECB) decisions on its Public Sector Purchase Programme (PSPP) - widely known as quantitative easing (QE) measures - and the soundness of the European Court of Justice’s (ECJ) subsequent ruling in Case C-493/17 Weiss. The PSPP was a bond-purchase mechanism intended to boost the Eurozone economy by decreasing borrowing costs for Member States. It ultimately allowed the ECB to source approximately €2.2tn of public sector debt.

In an unprecedented move, the FCC has declared the ECJ’s judgment – which rubberstamped the PSPP - as being ultra vires (i.e. that the ECJ had exceeded its powers) in Germany. It ruled that the country’s government and legislature violated the constitution by failing to properly monitor the ECB’s PSPP and gave a three-month ultimatum for the government to ensure that the ECB performs the requisite proportionality check de novo, failing which the Bundesbank and other German entities would be banned from participating in the PSPP.

In response, the ECJ tried putting the FCC in the naughty corner by issuing a brief press statement re-emphasising the fundamental tenet that “national courts are required to ensure that EU law takes full effect”. The European Commission’s President issued a similar statement adding that “possible next steps […] may include the option of infringement proceedings” against Germany. The ECB has not yet formally decided whether - and how - to respond. However, senior European leaders, such as Italy's Prime Minister Giuseppe Conte, have already condemned the FCC's judgment, a judgment that, for the reasons discussed below, could have far-reaching implications for the EU’s legal order, especially if national courts of other Member States were to follow suit.

The FCC’s key findings

The FCC’s decision is the latest chapter in a legal battle tracing back to 2015. At the time a claim was brought in the German courts by a group of 1,750 citizens questioning the legality of the ECB’s PSPP. The matter was subsequently put before the ECJ, which in turn ruled in favour of the ECB and upheld the soundness of the PSPP. The case was then remitted back to the FCC.

The starting point for the FCC’s latest ruling was that the ECB is subject to the “proportionality” principle, a principle enshrined in Article 5 of the Treaty on European Union (TEU) and binding upon all EU institutions. The TEU also mandates that the ECB may only exercise its designated powers to the extent necessary to fulfil its prescribed goals. In the eyes of the ECJ, the PSPP was necessary to meet the ECB’s inflation objective and so it was proportionate, especially given the safeguards against exceeding the limitation on credit facilities.

However, the FCC did not agree. After considering the ECJ's reasoning in depth - a step which many European lawyers would see as beyond the pale in itself -   the FCC formulated its own views on what the ECB’s mandate entails and how to exercise it. It found that it is “incumbent upon the ECB to weigh [the] considerable economic policy effects and balance them […] against the expected positive contributions to achieving the monetary policy objective” [emphasis added]. In the FCC’s view, these economic policy effects include “the risk of creating real estate and stock market bubbles as well as the economic and social impact on virtually all citizens, who are at least indirectly affected inter alia as shareholders, tenants, real estate owners, savers or insurance policy holders.”

The FCC also noted that when assessing the PSPP, the ECJ did not “give consideration to the importance and scope of the principle of proportionality” and so its ruling is “no longer tenable from a methodological perspective given that it completely disregards the actual effects of the PSPP’”. In other words, it held that the ECJ had grossly violated methods of legal interpretation when seeking to apply the “proportionality principle”. The FCC concluded that the ECJ’s review “does not satisfy the requirements of a comprehensible review” and thus had failed to fulfil its mandate. As such, the ECJ’s ruling was found to be ultra vires and therefore not binding in Germany.

A hammer-blow to the EU legal order

With this decision, the FCC has dealt a severe blow to the EU’s legal order.

First, the FCC directly accused the ECJ of exceeding its judicial mandate by endorsing the ECB’s policy without conducting an in-depth review of PSPP’s effects. It concluded that the ECJ “thus acted ultra vires, which is why, in that respect, its Judgment has no binding force in Germany”. Although it is not the first time a national court has made such a declaration,[1] it is the first time that a German court - and in fact Germany’s Federal Constitutional Court - has concluded that the ECJ exceeded its competence such that its ruling has no binding effect. By taking matters into its own hands, the FCC has effectively violated the EU treaty framework, which provides that the ECJ has exclusive power to interpret EU treaty law (Article 267 of the Treaty of Functioning of the European Union (TFEU) and adjudicate matters regarding the ECB (Article 35 of the Protocol to the TFEU).

But the FCC did not stop there. Having stripped the ECJ’s ruling off its binding force, it then launched an attack on the ECB. It held that the ECB manifestly exceeded its powers by failing to properly apply the principle of proportionality which, according to the FCC, mandates the balancing of the economic policy effects against the expected contribution to achieving the monetary policy objective. This approach is problematic for two reasons: first, it is inherently difficult to clearly distinguish monetary from economic policies – the latter evidently falling outside the scope of the ECB’s mandate in any event and straying dangerously into political territory. Second, it is striking that the FCC did not conclude that the ECB engaged in monetary financing of member states’ budgets, an action that is not allowed under Article 123 of the TFEU and which would therefore constitute an excess of power. Instead, although recognising that the ECB is afforded with “a margin of appreciation” it held that the ECB failed to properly apply the proportionality test in relation to monetary and economic policies.

By setting aside the ECJ’s judgment and questioning the ECB’s assessment in the way that it did, the FCC’s ruling was a double whammy. Not only did it pose a direct challenge to the supremacy of the EU judiciary but it also questioned the power of a central EU institution, the ECB, and cast doubt over the superiority of EU law – one of the EU’s core pillars. EU law takes precedence over any domestic legislation (including constitutional laws), the practical effect of which is twofold: national courts have to set aside any domestic rules that violate EU law[2] and the ECJ is the sole court empowered to rule on the legality of a measure adopted by the EU institutions[3]. Moreover European institutions, such as the ECB, are required to maintain a certain degree of independence and a “margin of appreciation”, at least vis-à-vis national courts,[4] to safely operate within the prescribed EU legal framework that has been pre-agreed by all Member States. The FCC’s ruling challenges these fundamental concepts.

A dangerous precedent

Second, the FCC may have set a dangerous precedent, albeit in a non-legal sense. Germany is, rightly or wrongly, seen as one of the two main national pillars of the EU, along with France. If Germany's Constitutional Court can strike down an ECJ ruling, other Member States could now rely on the FCC’s decision to question the ECJ’s powers, perform their own independent assessment and decide whether to comply with the ECB’s - and by extension any other EU institutions’ - programmes and/or rulings on an ad hoc basis. In this context, we note that ECJ rulings are not always fully or consistently reasoned (perhaps due to the political nature of the rulings) and judges do not issue dissenting opinions. If Member State courts can refuse to abide by ECJ rulings on the basis that they are unable to follow their assessment, then such courts may also question the ECJ’s superior status altogether and threaten the EU legal order.

This concern is not simply hypothetical. For some time now, the European legal community has witnessed Poland and Hungary condemning the creeping augmentation of the EU’s powers. The FCC's judgment may well have opened the door for the Polish, Hungarian and other national courts to challenge and even deny the ECJ's superior status and the supremacy of EU law. Worryingly, Mateusz Morawiecki, Poland’s prime minister, has already praised the FCC’s decision calling it “one of the most important” in the history of the EU as it establishes that “the ECJ does not have unlimited powers.”. The head of Poland’s Constitutional Court has added that “National constitutional courts are the courts which have the final word”.

Opening the door to challenging Achmea?

A potential immediate flashpoint could be challenging the applicability of the ECJ's decision in Slovak Republic v Achmea[5] to the numerous arbitral awards against Spain in favour of investors in that country's solar energy market. In Achmea the ECJ held that an arbitration clause in bilateral investment treaty (BIT) between two EU states contravened EU law, because it is for the courts of EU Member States and the ECJ to determine questions involving EU law.

The ECJ in Achmea reasoned:

  •  The BIT’s arbitration clause required the tribunal to interpret and apply EU law.
  • The EU’s founding treaties provide that it is for EU Member State courts and the CJEU exclusively to interpret and apply EU law.
  • An arbitral tribunal constituted under the BIT is not a ‘court or tribunal’ of a Member State. Consequently Member States could not have agreed to submit disputes which could involve the application and interpretation of EU law to that tribunal.

The judgment implied that (a) arbitral tribunals constituted under an intra-EU BIT lack jurisdiction and (b) any award rendered by such a tribunal would not be enforced by Member State courts.

 The Achmea decision sent shockwaves through EU legal circles. The European Commission (EC), which had long argued that any intra-EU investment disputes were exclusively a matter for EU law, the ECJ and national courts, made it clear that it considered that Achmea applies to all intra-EU investor-state arbitrations, including those under the multilateral Energy Charter Treaty (ECT), and directed Member States not pay out on awards made against them, and to request that their national courts set aside and/or not to enforce any intra-EU investor-state awards.

This was problematic on a number of levels. First, many of the investor-state arbitrations took place under the ICSID Convention, to which Member States had become signatories before the EU Founding Treaties came into existence. Secondly, the EU itself is a signatory to the ECT, which contains an arbitration provision. Thirdly, it requires investors to sue Member States in the national courts of those states (hardly a neutral venue). Finally, in one fell swoop, it undermines numerous intra-EU BIT and ECT arbitral claims already underway, include around 40 ECT claims against Spain by investors who claim their investments were rendered worthless by sweeping reforms to Spain's solar power incentive scheme.

Almost all ECT tribunals which have heard jurisdictional challenges on Achmea grounds have rejected those challenges. The reasoning has been varied, but usually focussing on the fact that the EU is a signatory to the ECT and there is no carve-out for intra-EU disputes; Achmea cannot apply to ICSID arbitrations since Articles 53 and 54 of the ICSID Convention provide that an ICSID award is binding on a signatory state, and must be recognised and enforced as if it were a final judgment of the signatory state’s national court. Consequently, a swathe of awards has been made against Spain. However, as matters stand, Member State national courts cannot enforce them as the EC argues they breach EU law.

The FCC's decision in the ECB case might embolden courts of some Member States to defy the EC's position on the applicability of Achmea to both intra-EU ECT and BIT awards[6], especially since the ECJ's reasoning is difficult to reconcile with the provisions of the ICSID Convention - indeed, in its decision in Achmea the ECJ did not even refer to the ICSID Convention or ICSID arbitrations. In practical terms this means that some national courts may allow the enforcement of intra-BIT/ECT awards (or continuation of pending intra-EU arbitrations) despite Achmea, an approach that would create further uncertainty in terms of enforceability of intra-BIT/ECT awards across the EU. And although on 5 May 2020 23 Member States signed an agreement which terminates intra-EU BITs, the agreement has not yet been signed by Austria, Finland, Sweden and Ireland and it does not cover intra-EU ECT disputes as these will be dealt with “at a later stage”. This further demonstrates that the EU legal order is increasingly fragmented as neither Member States (nor their national courts) have managed to streamline their views and take a uniform approach towards key issues such as investor-state arbitration or EU law’s superior status.

Further implications

From a legal standpoint, the FCC’s judgment is undoubtedly a seismic event. It poses a direct challenge to the supremacy of the EU judiciary and EU laws and undermines the very foundations of EU’s legal order.

At a political level, the damage that has been done to the EU legal hierarchy by the Constitutional Court of one of its core Member States remains to be seen. The decision could open the door to national courts departing from the ECJ's judgments on the basis that they are fundamentally flawed due to insufficient consideration of relevant factors, or other grounds, and hence ultra vires. The enforcement of intra-EU ECT awards might be the flashpoint for such battles.

However, it cuts deeper than that. With the ECB’s independence now on shaky ground, the FCC’s ruling could hamstring the ECB’s capacity to keep credit flowing and force it to think twice before loading its bazooka. And although the FCC did not attack the ECB’s latest Pandemic Emergency Purchase Programme (PEPP), it posed a burning question - and that question is highly relevant: is the ECB empowered to establish a wide bond-buying programme (such as the PSPP or the PEPP) and how would that be proportionate and compatible with Germany’s constitutional order?

These questions are yet to be answered. However on a practical level the ECB’s ability to do “whatever it takes” is now doubtful. And on a legal level the ECJ's unchallengeable supremacy – the very cornerstone of the reasoning in Achmea – is no longer a given. Only time will tell if this is a one-off blip, or the first crack that leads to the dam bursting.

Written by Partner Richard Power and Associate Nefeli Lamprou

 

[1] See the Dansk Industri case of the Danish Supreme Court or the Landtová case of the Czech Constitutional court

[2] Case 106/77 Simmenthal

[3] Case 314/85 Firma Foto-Frost

[4] It is worth clarifying that the ECB is still liable to compensate for any damage caused in accordance with Art. 340 and 268 of the TFEU  

[5] Case C-284/16

[6] Although it is to be noted that Germany’s Federal Court of Justice did, in fact, follow Achmea in setting aside the UNCITRAL award in the Slovak Republic v Achmea case itself.

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