The conflict between international investment treaty arbitration and EU law

Investors were awarded compensation under a bilateral investment treaty, but under EU law, payment of the award constitutes unlawful State aid. This Catch-22 situation is at the heart of a long-running case across jurisdictions.

In the latest development, the European Commission has decided to refer the United Kingdom to the European Court of Justice in relation to a judgement of the UK’s Supreme Court to lift the stay of enforcement of an ICSID arbitration award against Romania.

Background

An investor from a country takes comfort that its investments in another country are protected from State conduct which may frustrate or even destroy the investment when both countries have entered into an investment treaty. This could be a bilateral, regional or multilateral treaty. Many bilateral treaties (BITs) provide for the settlement of investor-state disputes by international arbitration through the International Centre for Settlement of Investment Disputes (ICSID).

This case concerns an ICSID award against Romania and how implementation of the award is considered by the EU as unlawful under EU law.

In 1998, the Romanian authorities adopted Emergency Government Ordinance No 24/1998 (EGO 24), granting certain investors in disadvantaged regions who had obtained permanent investor certificates a series of tax incentives, including, inter alia, facilities such as exemption from customs duties and value added tax for machinery, reimbursement of customs duties for raw materials and exemption from the payment of profit tax which applied for as long as the relevant area was designated as a ‘disadvantaged region’. Romania designated the mining area of Stei-Nucet, Bihor County, as a ‘disadvantaged region’ for 10 years.

When negotiations for the accession of Romania to the European Union started, the EU noted that there were a number of existing as well as new incompatible aid schemes in Romania which had not been brought into line. Consequently, on 26 August 2004, Romania repealed certain of the measures granted under the tax incentive schemes at issue as well as EGO 24.

ICSID Award Against Romania

In Micula and others v Romania, five investors filed an ICSID claim against Romania under the 2003 BIT between Sweden and Romania. The investors were two Swiss nationals, Mr Ioan Micula and Mr Viorel Micula, and three Romanian companies in which they had a majority shareholding. The claim was filed in 2005 before Romania joined the EU.

The dispute concerned Romania’s introduction and subsequent revocation of the economic incentives contained in EGO 24. The investors asserted that, in reliance on these incentives and, on the expectation that these incentives would be maintained during a 10-year period, they had made substantial investments in the Ştei-Nucet-Drăgăneşti disfavored region. The investors claimed that Romania’s premature revocation of the incentives was in breach of the BIT. The investors contended that, inter alia, Romania’s obligations to observe obligations entered into with them, and its failure provide fair and equitable treatment to the investments, breached Articles 2(4) and Article 2(3) of the BIT.

The Tribunal issued its Award on 9 December 2013 dismissing by majority the investors’ claim under Article 2(4) of the BIT whilst finding that Romania had failed to provide fair and equitable treatment in violation of Article 2(3) of the BIT. The Tribunal awarded damages to the investors in the sum of RON 376,433,229 (approx. £70m) plus interest until full payment of the award.

European Union Law on State Aid

The Romanian government made partial payment of the compensation under the ICSID award. Subsequently the European Commission issued a decision that any compensation constituted unlawful State aid. That decision was challenged before the EU courts but ultimately the European Court of Justice (ECJ) upheld the decision.

Taking advantage that under the ICSID Convention investors can enforce ICSID awards in all contracting states, some of the investors brought an action before the courts in the UK to have the ICSID award recognised and enforced. That action was appealed by Romania resulting in a stay on the enforcement of the award, but ultimately the UK Supreme Court lifted the stay.

On 9 February 2022 the European Commission decided to refer the UK to the ECJ. The heart of the issue is whether the UK courts' recognition and enforcement of an ICSID award (implementation of which the EU determined was incompatible with EU law) is an infringement by the UK of EU law.

The UK Supreme Court’s judgment

The UK and Romania became parties to the ICSID Convention, which provides for the recognition and enforcement of ICSID awards in contracting states, prior to becoming members of the EU.

One of the issues before the UK Supreme Court was whether Article 351 of the Treaty of the Functioning of the European Union (TFEU) – which identifies that obligations under the EU Treaties do not affect rights and obligations of countries prior to their joining the EU – gave rise to a risk of conflict which required the imposition of a stay of enforcement of the ICSID award pending the outcome of the proceedings before the EU courts.

Romania and the European Commission submitted that the duty of sincere co-operation under Article 4(3) of the Treaty of the European Union required the UK courts to impose a stay on enforcement. The Supreme Court rejected this submission, finding, firstly, the case law of the ECJ makes clear that, as a matter of EU law, questions as to the existence and extent of obligations under prior treaties in the context of Article 351 TFEU are not reserved to the EU courts. Secondly, although the claimants had raised an issue under Article 351 TFEU in the proceedings before the EU courts, by contrast, the issue before the Supreme Court concerned the UK’s obligations to implement the ICSID Convention and to recognise and enforce the award under Articles 54 and 69 of the ICSID Convention. The extent of the UK’s obligations under those articles had not been raised before the EU courts. There was therefore no congruence of the issues before the UK domestic courts and the EU courts. Thirdly, the prospect of an EU court addressing the applicability of Article 351 TFEU to pre-accession obligations under the ICSID Convention in the context of the present dispute was remote. The Supreme Court concluded therefore that the duty of sincere co-operation between EU member states was not applicable and there was no impediment to the lifting of the stay on enforcement of the ICSID award, which was an unlawful measure in international law and unjustified and unlawful in domestic law.

The European Commission’s Decision

The European Commission’s stated reasons for referring the UK to the ECJ is that the UK has:

1. breached the principle of sincere cooperation by adjudicating a legal question already before the EU courts, namely the interpretation and application of Article 351 TFEU and the validity of the Commission’s decision in this respect;
2. infringed on Article 351 TFEU by wrongly by misinterpreting and misapplying that provision;
3. infringed on Article 267 TFEU by failing to make preliminary reference to the ECJ on the application of Article 351 in relation to the interpretation and implementation of an ICSID award in the EU and the validity of the Commission’s decision in this respect; and,
4. infringed on Article 108(3) TFEU by failing to respect, regarding the implementation of the arbitral award, the suspensive effect on the arbitral award of the Commission’s 2014 decision to open a formal State aid investigation procedure.

The Commission states that it “considers that the UK Supreme Court judgment has significant implications for the application of EU law to investment disputes, for (i) arbitral awards rendered on the basis on an intra-EU bilateral investment treaty or (ii) the intra-EU application of the Energy Charter Treaty. The Commission considers that UK courts' recognition and enforcement of such awards is incompatible with EU law and would circumvent and undermine the Commission's efforts to ensure the effective implementation of judgments reiterating the primacy of EU law over arbitral awards in the context of intra-EU investment disputes, which are incompatible with EU law and thus unenforceable.”

Comment

Is Brexit relevant to the matter? Yes and No. No, because the case concerns a matter that occurred when the UK was an EU Member State. Under Article 87 of the UK-EU Withdrawal Agreement, for four years from the end of the transition period, the Commission can bring new cases before the ECJ concerning an alleged breach by the UK of EU law prior to the end of the transition period. Any such judgments of the ECJ are binding on the UK. However, potentially yes because the question could be raised, which is superior, the UK’s obligations under ICSID or its obligations under the UK-EU Withdrawal Agreement. That question might itself be played-out in the Courts, although arguably such a dispute should be considered by the Joint Committee, a body constituted under the UK-EU Withdrawal Agreement.

How does this affect State aid? While there has been considerable expansion since the outbreak of COVID-19 of Member States’ ability to grant lawful State aid, the substantive law has not changed except for Covid-19 specific aid. Investors should always be mindful that any benefit provided by a European Member State to a business or investment venture risks being construed as unlawful State aid and may have to be repaid. It is recommended to seek legal advice on whether there may be elements of unlawful State aid in your investment when a State measure is important to its value.

And what if an investor believes an EU Member State has acted in a way that breaches its obligations under an investment treaty even though unlawful State aid may be at issue? The door is still open to bring a treaty claim if an EU member State has violated its obligations under an investment treaty and to seek an award against the State. Investors can seek enforcement in any ICSID contracting state, most of which are not EU Member States and thus the issues described in this article do not directly apply.