Investor-state arbitration and climate change: a plate-spinning act?

Nowadays, the parameters that define the human race’s ability to survive are being redrawn. Past generations have lived through countless wars, widespread famine, droughts, and unexpected catastrophes. The difference between then and now is that we are on the brink of reaching climate-linked tipping points.

As supported by overwhelming scientific evidence, including the latest climate report published by the UN’s Intergovernmental Panel on Climate Change (IPCC) on 9 August 2021,[1] if the levels of greenhouse gases in the atmosphere push global temperatures beyond these tipping points in the near future, this will lead to severe and irreversible consequences for future generations.[2] Accordingly, climate change poses an existential threat to the survival of life, as we know it, on our planet. No-one assumes that reducing our collective carbon footprint can succeed solely based upon voluntary co-operation among businesses, governments and individuals. For better or worse, this mighty endeavour requires enforcement and regulatory intervention. Here lies the complexity. Planning and implementing regulatory measures aimed at combating climate change requires governments to spin many plates simultaneously, juggling the potentially conflicting objectives of multiple interests and actors. (The current Covid-19 pandemic adds further complexity to the mix). Governments accordingly find themselves in a complex position where diverging interests will clash and, continuing with the analogy, plates may break.

The field of climate change litigation presents a paradigm of the position in which governments are found.  It is no coincidence that many of the growing number of climate-related disputes—it is estimated that these disputes have almost doubled since 2017[3]— are against governments.

Some governments have been sued for doing too little in response to the climate crisis.  Some have been sued for what can be characterised as doing too much, particularly under investment treaties. Others have been sued, also under investment treaties, for reversing measures ultimately aimed at combating climate change.

Here, we take stock of current litigation and arbitration trends relating to climate change, discuss the measures being taken in response to climate-related investment treaty claims and offer our thoughts on what governments could do to prevent the proliferation or escalation of such disputes.

Doing too little? Court litigation and potential investment treaty claims

Let us begin with situations in which governments have been sued for doing too little. Typically, such cases are based on constitutional or human rights law, or administrative and planning legislation.  Claimants have succeeded in four landmark cases against France, Germany and the Netherlands.

In France, on 1 July 2021, the highest Administrative Court (Conseil d’État) issued a landmark ruling in the Grande-Synthe case, giving the government nine months to take all the necessary measures to curb greenhouse gas emissions produced on the national territory to ensure it complies with its national climate targets under the Paris Agreement.[4]  This decision comes in the wake of another historic French ruling earlier this year in Notre Affaire à Tous and others v France. In this case, the Paris Administrative Court (Tribunal Administratif de Paris) considered a claim based on Articles 2 and 8 of the European Convention on Human Rights (ECHR),[5] the French Charter for the Environment and the general principle of law protecting every citizen's right to live in a preserved climate system.[6] On 3 February 2021, the court held that the French government was liable for failing to achieve its targets for cutting greenhouse gas emissions, and this had resulted in environmental damage.  However, the court refused to award damages for ecological harm since, according to the court, this might be reversible.  The court awarded the claimants (four NGOs) the "symbolic sum of 1 euro for moral prejudice" and ordered the government to disclose the steps it plans to take to meet France's climate targets and carbon budgets. 

In Germany, a claim filed by young environmental activists has resulted in the country's Federal Constitutional Court ruling on 24 March 2021 that Germany's Federal Climate Change Act 2019^[7] is incompatible with fundamental rights because it leaves much of the burden of reducing emissions to years after 2030.^[8] The court laid down a new “inter-generational standard” for climate protection as a human right, stating that "practically every freedom is potentially affected [by these future emission reduction obligations], because today almost all areas of human life are bound up with greenhouse gas emissions […] and could therefore be threatened by drastic constraints after 2030".^[9]  The ruling is based, among other things, on Article 20(a) of the German Constitution (Grundgesetz), which requires the government to take climate action, and Germany's obligations under the Paris Agreement.  The court has ordered the government to enact provisions by the end of 2022 that specify in greater detail how reductions in emissions are to be adjusted after 2030. 

In the Netherlands, the Dutch Supreme Court in 2019 heard a landmark climate justice case, Urgenda Foundation v Netherlands, concerning the Dutch government’s efforts to reduce greenhouse gas emissions. An initial ruling in 2015 accepted that the Dutch government had a constitutional duty to protect its citizens from climate change and ordered it to take more ambitious action by reducing emissions by at least 25% by the end of 2020, compared to 1990.  The judgment was appealed, but ultimately upheld by the Dutch Supreme Court, which affirmed that the government had breached its duty of care under Articles 2 and 8 of the ECHR.[10]  

In contrast with these cases in mainland Europe, claimants have been less successful in climate change-related cases pursued against the US and UK governments.

In Juliana v USA, 21 young people and the organisations Earth Guardians and Future Generations alleged that, by maintaining a national energy system powered by fossil fuels long after knowing that it contributes to climate change, the US government was violating their constitutional rights to life, liberty and property.  On this basis, they requested an order that the US Federal Government devise a remedial plan for the reduction of greenhouse gas emissions. The Court of Appeals for the Ninth Circuit refused the request, holding (by a majority) that "any effective plan would necessarily require a host of complex policy decisions entrusted to the wisdom and discretion of the executive and legislative branches."[11]

In the UK Supreme Court case of R (Friends of the Earth Ltd and others) v Heathrow Airport Ltd (2020), the claimants tried to block expansion of Heathrow Airport. [12]   They argued that the expansion was inconsistent with government climate targets, but the court held, among other things, that the mere announcement of such targets did not constitute "government policy" for the purposes of the relevant planning legislation.[13]  It is worth noting, however, that permission for the expansion project has yet to be given, and climate change issues may be considered again at a later stage.

In addition, states in theory could face claims under investment treaties on the basis that their insufficient action has harmed an investment.  Most countries in the world have concluded a network of hundreds of bilateral and multilateral investment treaties (BITs and MITs, respectively) that offer significant legal protections. Most of such treaties, the majority of which were concluded in the 1990s and 2000s, are silent on climate change issues.

In particular, many investment treaties contain a guarantee referred to as the “full protection and security” (FPS) standard.  In general terms, under this guarantee, states have the duty to protect relevant investments from harm.  Accordingly, in theory, investors could invoke the FPS standard to allege that states have failed to take relevant preventative measures against climate change, putting foreign investors at risk of loss or damage to their investments (for example, investors whose investments suffer damage due to droughts or hurricanes).[14]  In addition, many investment treaties afford broad protections under the fair and equitable (FET) standard. Due to the breadth of this standard, investors may also try to advance climate change-related claims under the FET protection. A key question in respect of such potential claims will relate to the causal link between inaction and harm.

Doing too much? Investment treaty claims

While governments are facing claims urging greater speed and more radical action, they must also defend claims made by international investors in respect of regulatory measures taken (or said to be taken) to combat climate change. These claims are generally based on investment treaties.  In this context, typically, an investor alleges that a treaty provision has been breached by a state introducing environmental legislation or regulations, implementing them in a certain way, or changing the way they work.  

The question that is virtually always at the heart of the Investor-State Dispute Settlement system (ISDS) (and the law of expropriation or takings at a municipal level for that matter) relates to risks and, ultimately, money: whether the state or the investor should bear the risk of losses arising from the regulatory changes in issue.  Thus, in the context of states taking measures to combat climate change, the question is often who should bear the losses arising from the phasing out of unclean energy sources.  Is it the investor (whose assets run the risk of being stranded) or the state (which may be under budgetary constraints)?

It is important to note that a public purpose—for example, addressing the climate crisis—does not in itself amount to a reason to make investors pick up the tab. This flows from the provisions on legal expropriation contained in most investment treaties that rest on the notion that investors whose property is taken for public purposes ought to receive compensation. 

For example, the question as to “who pays” was put forward in February 2021 by the German utility company, RWE, which filed an Energy Charter Treaty (ECT) [16] claim for compensation against the government of the Netherlands, which plans to end all coal-fired power production by 2030. RWE alleged that it has not been given sufficient time or funds to carry out the necessary works for its power plant in Eemshaven to transition from burning coal to biomass.  The Eemshaven plant is less than six years old, as is another power plant run by Uniper, another German utility company which has reportedly threatened legal action.[17] 

Reversing course? Investment treaty claims

Meanwhile, renewable energy investors have been using investment treaties to claim against states for allegedly reversing course in respect of regulatory frameworks designed to encourage investment in the renewable energy sector.  Spain, Italy and the Czech Republic have been badly hit by these claims.  For instance, within a period of just ten weeks (from 31 May to 2 August 2019), five different arbitral tribunals ordered Spain to pay investors compensation for the reform of its solar energy incentive scheme, mainly on the basis of breaches of the duty of the FET standard in the ECT[18]. To date, over 40 such claims have been pursued against Spain. 13 ECT claims have been lodged against Italy and six against the Czech Republic as a result of these countries’ decisions to modify their original renewable energy investment incentive frameworks, which had been implemented in the early and mid-2000s.[19]

Elsewhere, Romania is also defending a claim, brought under the ECT by LSG Building Solutions and others, in relation to a scheme based upon green certificates that encouraged investment in renewable energy.[20]  While the scheme was successful in boosting the production of renewable energy, it also led to price rises for consumers. On this basis the Romanian government reformed the scheme and reduced the number of certificates issued.  The claimants allege that this reform caused them losses of more than £250m.

Claims of this kind are not limited to Europe or the ECT.  The Koch group of companies, for example, has filed a claim against Canada under the North American Free Trade Agreement (NAFTA) in relation to the Ontario provincial government's decision in 2018 to cancel a cap and trade programme aimed at reducing carbon emissions.  The claim was based not just on the cancellation itself, but on legislation limiting legal redress and compensation, which the Koch group argued amounted to unlawful expropriation under NAFTA.  The Koch group, which has bought and sold publicly issued emissions allowances, alleges that it has suffered losses exceeding US$30m as a result.[21]

Fighting on several fronts

Governments therefore find themselves fighting legal battles on several fronts.  They must grapple with the tension between, on the one hand, going further and faster with environmental legislation, particularly to pre-empt claims by NGOs and others, and, on the other hand, ensuring they fully meet their legal obligations to international investors.  There are different ways in which governments are dealing or may deal with this (perceived or real) tension or dilemma.

First approach that governments may adopt: Replacing or amending investment treaties

A first approach consists of ensuring that investment treaties have provisions that deal with climate change issues.  At least three potential courses of action exist.

First, in theory, the most straightforward course is for states to agree to new bilateral investment treaties.  Here, states have freedom to deal with climate change issues as they see fit.  For example, the Netherlands' model BIT of 2019 makes specific reference to environmental protection.[22]  The chink in the armour is that in many cases, investment treaties may already be in place.

The second course involves amending existing treaties. Two scenarios exist.

First, in relation to BITs, two contracting state parties could agree to add provisions on climate change to an existing treaty. This, however, could give rise to complex situations, particularly if disputes are already afoot. Of course, the state parties could instead agree to terminate the treaty in issue and replace it with a new treaty that contains climate-change related provisions.  This approach, however, can give rise to thorny questions, at least in two respects.  First, significant issues may arise in relation to existing disputes.  Second, issues are likely to arise from the effect of sunset clauses protecting the rights of investors for some years after termination.

Second, a more complex scenario involves amending multilateral treaties, particularly ones with numerous state parties.  The ECT, with 53 signatories and contracting parties (including the EU and Euratom), is particularly relevant.[23] The EU Commission has argued that the ECT needs a general overhaul. In particular, it has described the ECT’s investment protection provisions as "outdated", saying that they no longer "correspond to modern standards”.[24]  Among other things, it wants an explicit right for contracting states to legislate to achieve "legitimate public policy objectives".[25]  This is partly to do with state aid, but also with the EU Commission's view that, without fundamental reform of the ECT, it may not be able to reach its goal of carbon neutrality by 2050.  Somewhat echoing the EU Commission’s concerns, in an open letter signed by almost five hundred scientists and climate leaders, the ECT has been described as a "major obstacle to implementation of the Paris Agreement and the European Green Deal".[26]

Without engaging in a debate as to whether the ECT is or is not such an obstacle, one should not lose sight that this treaty provides a framework that protects investments in all kinds of energy, including renewables.  In other words, the availability of the protections offered by the ECT makes investing in the renewable energy sector more attractive. Various options have been considered to amend the ECT, including the EU’s proposal to phase out the investment protection of fossil fuels. The last round of negotiations in this respect took place in Brussels in July 2021.[27]

A “nuclear option” of simply ditching the ECT altogether is far from straightforward.  As the ECT is a multilateral treaty, according to the Vienna Convention on the Law of Treaties (VCLT), bringing the treaty to an end in general would require the consensus of all contracting parties[28]. This is unlikely.

Thus, in practice, the states that are unhappy with the ECT are left with only one option: withdrawing from (“denouncing”) the treaty.  Italy notified its withdrawal on 31 December 2014, becoming effective on 1 January 2016.[29]  The ECT, however, contains a sunset provision at Article 47(3), under which existing investments are protected for 20 years after the date of withdrawal becomes effective.[30] Thus, investors who made qualifying investments in Italy prior to 1 January 2016 will still receive full protection under the ECT until January 2036.  Accordingly, a state’s withdrawal does not achieve a quick end to the protections that the ECT affords.

Second approach that governments may adopt: Managing investors' expectations

As a second approach, governments may be able to deal with the tension alluded to above within the existing investment treaty framework (including the ECT).  Most disputes involving the “too much” and “reversal” aspects discussed here relate to regulatory stability.  The FET standard lies at the heart of most such disputes, in particular the obligation of a host state to respect the legitimate expectations that led an investor to invest in the country.  An investor’s legitimate expectation in many such cases relates to the stability of the regulatory system.  In the cases involving Spain, Italy and the Czech Republic, for example, claimant-investors have argued that they committed to long-term investments in the renewable energy sector in reliance on the states’ promises of stability of the incentives they once offered.[31] The disputes have often centred on what the states specified in the relevant legislation or regulations, and what the investors should have understood at the time.

For example, in Masdar Solar and Wind Cooperatief UA v Kingdom of Spain,[32] the tribunal concluded that the investor's expectations were legitimate, partly because it had complied with specific conditions enabling it to benefit from the stability offered by Spanish legislation and had conducted extensive due diligence in this respect.  Here, the tribunal considered the different kinds of commitments that the government had made.  It found that the claimant's expectations had not been met, and the FET standard in Article 10(1) of the ECT had been breached, resulting in an award of approximately EUR 65m plus interest. 

By contrast, in Foresight Luxembourg Solar 1 S.Á.R.L., and others v Kingdom of Spain,[33] a dissenting tribunal member refused to accept that the claimants had conducted adequate due diligence, which he said was a "prerequisite for the viability of a legitimate expectations claim".[34]  However, the majority took a different view, finding for the investors  and concluding that they had a legitimate expectation that the country's legal and regulatory framework would not be "fundamentally and abruptly altered", thereby depriving them of a significant part of their projected revenues.[35]

Against this backdrop, the recommended approach for limiting stability-related claims, particularly based upon legitimate expectations, not surprisingly, is increased clarity.  Governments and legislatures should ensure that it is clear from the outset what changes in law and regulations a foreign investor can expect for investments in the country in certain fields.  The limits, ideally, should be self-explanatory—warts and all—to avoid debates taking place before an arbitral tribunal if changes are enacted.  A focus on regulatory clarity would help to resolve the tension between the desire of a government to retain its regulatory prerogatives with the need to entice foreign investment into the country.  Clear legislation and regulation would avoid trapping investors into the pitfall of what is sometimes referred to as the “obsolescing bargain”: once a country has attracted and benefitted from a desired investment, the tables are turned to the detriment of the investor. If a state’s normative framework clearly establishes the scope and limits of the regulations applicable to foreign investments in a specified sector (for example, energy), this would prevent an investor from claiming that the state has thwarted its legitimate expectations by introducing predictable changes in this sector.

Third approach that governments may adopt: Non-investment considerations once a dispute has arisen

In principle, in investment treaty arbitrations, states may put forward arguments based upon non-investment considerations—that is, states' environmental, human rights and public health obligations under international law.

In such cases, tribunals will need to resolve the tensions that exist between conflicting obligations that may arise in certain situations, for example, balancing the need to protect the environment with the need to guarantee the protection of the investor.  In practice, there are few rules in customary international law governing which obligation should take precedence over the other, or more broadly, dealing with the tension involving different obligations.  The defence of necessity can be viewed as a rule dealing with such tension. [36] In specific situations, a state may argue that a breach of an investment treaty is justified by the need to preserve a non-investment consideration such as human rights or the environment.[37] The defence of necessity was the subject of several investment cases relating to the emergency measures that Argentina adopted during its 2000-2001 financial crisis. For example, in Suez v Argentina, the Argentine government claimed that human rights law required it to adopt certain measures to “safeguard the human right to water” of its inhabitants.[38] However, in practice, the defence of necessity has had limited success.  This is not because it brings into play non-investment considerations, but because under customary international law strict conditions must be satisfied for this defence to work.[39] In addition, investment treaty tribunals have not adopted a uniform approach in their interpretation and application of necessity.[40] 

Alternatively, some authors posit that tribunals may be able to consider environmental obligations as part of the applicable law of an investment treaty dispute. This is referred to as the principle of systemic integration, enshrined in Article 31.3(c) of the VCLT, which provides that, when interpreting the terms of treaties, “any relevant rules of international law applicable in the relations between the parties” shall be “taken into account, together with the context”.[41] As a commentator has observed,[42] the VCLT was drafted to assist with the interpretation of treaties, not to settle treaty conflicts.  The systemic integration principle does not require a choice to be made between conflicting state obligations. It simply allows tribunals to interpret norms of investment protection—especially broadly formulated provisions such as the FET standard—by reference to existing obligations that do not, strictly speaking, relate to investment protection.[43]  Although the systemic integration principle is not explicitly referred to in any investment arbitration awards, some investment treaty tribunals have supported the view that investment treaties must be interpreted within a wider juridical context, incorporating, amongst other things, different sources of international law.[44]  It remains to be seen whether this approach will have traction in the context of states adopting measures in compliance with their obligations under the Paris Agreement.

Balancing all the spinning plates

As the world transitions to a greener economy, governments must adapt to complex new realities within existing legal frameworks, including under existing international investment treaties.

In the context of investment treaty law, states should focus on increasing their regulatory clarity to reconcile the different interests at stake.  Clarity in new legislation and regulations introduced by a state would have numerous benefits. It would provide guidance for arbitral tribunals to assess whether the expectations of investors at the time of investing were legitimate or not.  It would do away with the risk of states engaging in “obsolescing bargains” with foreign investors. Ultimately, it may lead to fewer investment treaty claims against governments as they continue their efforts to mitigate and adapt to climate change.  There is an awful lot to do, but this would be a good start.