Investment arbitration and the new Spanish reform of the electricity sector
The Spanish government approved last year a new energy reform which affects once again the retribution of existing renewable energy installations. For that reason many foreign investors have started proceedings against the Spanish State alleging a breach of the Energy Charter Treaty.
In 2011 a group of international funds decided to invoke the ECT in order to defend their investments in photovoltaic energy in Spain. During 2013 five more claims have been filed by construction companies and international funds with interests mainly in thermosolar energy.
Last year I wrote an article on this blog investigating the possible infringements and the effect a favorable award could have on Spanish investors. Now I would like to concentrate my analysis on the feasibility of the claims against the new energy reform, followed by a clarification regarding who is entitled to claim and which are the costs of an arbitration proceeding. Finally I will make a comparison between the international arbitration tool and the strategy we are following on behalf of our clients.
1.Is the new energy reform breaching Spanish obligations under the ECT?
The new electricity sector reform has been introduced by Royal Decree-Law 9/2013, followed by a new Law of the electricity sector, Law 24/2013, as well as by a series of royal decrees, some of them still pending approval.
The main goal of the reform is to limit the tariff deficit of the Spanish electricity sector and for this purpose, among other actions, it replaces the feed-in tariff scheme applicable to electricity generation from renewable sources, cogeneration or waste (commonly referred to as "special-regime installations") with a new remuneration system applicable retroactively and based on the reasonable profitability of the investment put in place by an "efficient and well-managed company".
Like for the previous cutbacks provided by RDL 14/2010 and RD 1565/2010, the ECT articles that could have been breached by the new regulation are article 10 and 13 of the ECT.
In first place Article 10 concerns the protection of investments and provides that contracting parties shall encourage and create "stable conditions" and ensure a "fair and equitable treatment". Furthermore “investments shall also enjoy the most constant protection and security” while “unreasonable or discriminatory measures” should not be allowed. Additionally the last sentence of the first paragraph of Article 10 contains an umbrella clause that entails a general commitment to respect every contractual obligation: “Each Contracting Party shall observe any obligations it has entered into with an Investor or an Investment of an Investor of any other Contracting Party”. Spain directly expressed its intention to be bound by this clause by not signing Annex IA. Thus the new reform could constitute a breach of a contractual obligation Spain has undertaken with international investors in the moment in which they decided to invest in RES plants, an investment granted by the Spanish official journal.
Secondly, article 13 provides that an investment cannot be nationalized, expropriated or subjected to measures having equivalent effect except when the following requisites are met: public interest, no discrimination, due process of law and, notably, the payment of prompt, adequate and eﬀective compensation.
Nowadays the most common kind of expropriation is in fact an indirect expropriation also called “creeping expropriation” which is defined as a “hidden expropriation operated continuously through rates, regulations and legislative changes that actually deprives the investors of a substantial part of their investment”. The retroactive change in the structure itself of the support schemes resulting in a relevant cutback of the retribution clearly entails a deprivation of substantial part of the investment.
In conclusion, and regardless what the Spanish Supreme Court says concerning a possible breach of the ECT (Decision 4594/2012 between others), we think that the arguments of the claimants are solid and there is a real chance that an arbitral tribunal would consider that article 10 and 13 of the ECT have been breached.
2.Who is entitled to claim under the ECT?
Article 1(6) and article 1(7) contain a very broad definition of investment and investor: the ECT covers basically every kind of asset, share or interest held by a national of a contracting party as well as by a legal person organized according to the laws of a contracting party.
Nevertheless article 17 allows member countries to deny the investment protection 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. Notably article 17 does not include investors from the country in which the investment is made and that has allowed in the past nationals of the State hosting the investment to claim under the ECT dispute resolution mechanism (see Yukos v. Russian Federation). Thus if a Spanish investor controls a legal entity organized according to the law of another contracting party and this entity holds shares in a RES installation in Spain he will be able to benefit from the ECT investment protection framework.
Some Spanish PV producers asked us if they can change their status and qualify as “international investors”, for example by selling shares to a foreign holding, and thus become eligible for the ECT dispute resolution mechanism. Unfortunately this is not possible because investors have to meet the requisites when the damage occurs. This view is shared by arbitration courts in two notable cases involving Turkish companies, namely Cementownia "Nowa Huta" S.A. v. Republic of Turkey and Europe Cement Investment and Trade S.A. v. Republic of Turkey.
In conclusion it is not possible for national investors to appeal under the ECT although the broad definition of a foreign investor may guarantee this status also to a Spanish national which owns a company abroad holding shares in a RES plant.
3.The costs of the arbitration. Is it only for big investment funds?
The costs point is always an issue when it comes to international arbitration as they may be very high and it is not easy to predict the final amount.
In particular the following costs have to be taken into account:
a)Lawyers’ fees: Defending the interests of the clients before an arbitration court requires an outstanding legal work;
b)Expert report: Damage quantification is crucial in arbitration proceedings;
c)Travel expenses: the international nature of the arbitration often implies high travel expenses;
d)Arbitration costs: include the fees of the arbitrators (normally a panel of three) plus the costs of the tribunal;
e)Respondent legal fees: when the claimant’s pretentions are not recognized the Tribunal may rule that it has to cover partially or totally the respondent’s legal fees.
As a result the overall cost of an arbitration proceeding under the ECT may increase from a few hundred thousand euros up to several millions in some cases. Consequently this tool is only accessible to large size installations owners or to smaller investors if they combine their claims and share a relevant part of the arbitration costs. If we convert this in megawatts, as customary in the RES sector, it would be generally not viable for clients controlling less than 50 MW and it becomes gradually more convenient as the number of MW rises.
4.Investment arbitration v. European Law strategy
We will now underline the differences between our main strategy and international arbitration. At Holtrop we are currently representing more than 1.200 producers and some of them are foreign investors from France, Germany and the Netherlands. Our legal strategy is based on European Union Law and can be undertaken by every PV and RES producer in Spain.
First of all the legal basis is different: while the arbitration is based on the ECT, which means international Law, our claims are based on EU Law, in particular on the infringement of EU general principles of no discrimination and legitimate expectation as well as on breaches of some provisions contained in Directive 2009/28/CE and 2009/72/CE.
There is no doubt that a claim under the ECT relies on very solid basis but as we widely advocated on our blog the infringement of EU law principles and provisions are absolutely flagrant as well.
The main benefit of the arbitration is probably the fact that it is a totally independent proceeding where national courts are not involved while one of the main concerns of our EU Law strategy is how much time it will take for a national court to finally ask for a preliminary ruling to the CJEU.
Regarding the duration of the proceeding international arbitration has a slight advantage as the average lengths is around 2,5 years while a national proceeding with preliminary ruling requires at least 3 years. Nevertheless many arbitrations last way longer. PV investors v. Spain for example entered now in its third year.
As we have seen in the previous paragraph arbitration costs are prohibitive for many RES producers while in our claims the aim was from the start to bring together a big group in order to share costs and be able to offer a high level of protection also to these renewable energy producers, mainly owners of small PV plants, that, for costs reasons, had been excluded from the budgets of big law firms. Currently our fees, which are calculated for MWh, are very competitive also for medium and big sized clients.
In conclusion, while a Spanish investor has no choice, for an international company or fund the decision between the two options has to be carefully pondered. In our view both strategies are feasible and are worth the intent. Therefore this choice should rely on an accurate cost benefit analysis and inevitably, considering the high degree of uncertainty in the Spanish RES sector nowadays, on the personal intuition that one way will be quicker and more successful that the other.