New regulation sets out financial responsibility for investor-state disputes between the European Union and third countries

Today (17 September 2014) a new European Regulation enters into force (EU No 912/2014) with wide-ranging implications for the global investment community. The Regulation allocates financial responsibility going forward, for claims brought by non-EU investors for harm done to their investment within the European Union. Depending on who was involved in the treatment in question – a Member State or a body, institution or agency of the EU itself, responsibility is allocated accordingly.

The rules will only be applied to investor-state disputes brought under agreements to which the EU is itself a party and which incorporate an Investor State Dispute Settlement (ISDS) mechanism. The Energy Charter Treaty (ECT) is one such treaty already in existence and several bilateral investment treaties (BITs) between the EU and third states are in the process of being negotiated, in some cases with a view to replacing the current BITs between EU Member States and third states. This forms part of a wider re-evaluation of investment issues and the relative competences of individual Member States and the EU.

EU Trade Commissioner Karel De Gucht has described the Regulation as "another building block in our efforts to develop a transparent, accountable and balanced investor-to state dispute settlement mechanism as part of EU trade and investment policy."

European investment policy – the context

Since the Treaty of Lisbon came into force in 2009, amending various pre-existing treaties, ISDS has fallen within the exclusive competence of the EU (under Article 3(1) of the Treaty on the Functioning of the European Union).  As a result, the European Commission is responsible for negotiating future investment agreements on behalf of the EU and in place of individual Member States. Until now, it has been unclear as a matter of principle, to whom third countries will need to direct their claims under these agreements and who will ultimately pay out.

The European Commission is currently negotiating on investment protection (whether as a stand-alone agreement or as part of a Free Trade Agreement) with many non-EU countries including China, Canada (due to be signed later this month), India, Japan, Singapore and the United States. (The latter, the Transatlantic Trade and Investment Partnership (TTIP) is currently on hold while a public consultation on the ISDS provisions is finalised - see our earlier blog post here on this consultation.) In some cases it is doing so with a view to these taking the place of existing treaties between Member States and third countries but there is no blanket policy.

In negotiating these agreements, the EU's approach is to give foreign investors a high level of protection, but not higher than that given by Member States to fellow Member States. It aims to improve existing ISDS mechanisms by requiring increased transparency, accountability and predictability, for example so that all documents and hearings are public.

These agreements are only one side of the coin. EU policy also extends to intra-EU BITs (BITs between Member States) upon which there remains disagreement at national court level as to their compatibility with EU law.

What does this Regulation cover?

The new Regulation sets out a framework to manage investor-state disputes. In the event that a claim is brought against an EU Member State, for example for breach of the fair and equitable treatment standard, it determines, practically speaking, who is to be financially responsible. Whilst the EU has brought ISDS under its remit, it does not go as far as to take all financial responsibility for the actions of all its Member States. Rather it sets out a nuanced approach to determine who bears responsibility for disputes including who should pay the costs of bringing such a claim and who should ultimately pay any resulting compensation.

The financial responsibility will usually flow from who has responsibility for the treatment in question, although a Member State will not be held responsible where the treatment is required by EU law, for example, by implementing an EU directive. The Regulation also foresees situations in which financial responsibility for a given claim will be shared between the EU and the Member State, according to the specific acts forming the basis of the claim. Whilst the Member State and EU are implored to "consult closely…to reach agreement on the apportionment of financial responsibility" (Recital 20), there may, of course, be disagreement between them. In such a case, the Commission is to pay damages awarded but request that the Member State reimburse the EU's budget plus resulting interest. The EU is given implementing powers to enforce this.

As well as the apportionment of financial responsibility, the Regulation contains sections on conduct of disputes and settlement. As regards who should defend the claim: where either a Member State or the EU bears financial responsibility, it is also responsible for defending the claim, allowing it the opportunity to put its case forward. The Regulation allows for cases where a Member State may defer to the EU to represent it, perhaps for reasons of technical expertise, but without passing on its financial responsibility. This would be done in close cooperation with the relevant Member State. It sets out a procedure whereby if the EU receives an arbitration request, it would immediately notify the Member State concerned and vice versa. Where the EU wishes to settle a dispute and this has ramifications for the Member State concerned, it would also need to be done in close cooperation with that Member State.

The Regulation purports to allow Member States and the EU to each continue to take responsibility for their own actions. In this sense there is an element of sensible pragmatism. Whilst it does not rule out disputes over the issue of financial responsibility, it also paves the way for cooperation and transparency amongst the stakeholders and sets out clear procedures to determine responsibility for the various aspects of a claim. The clarity will be welcome to investors who will want to be sure that the costs of a claim will not be passed from pillar to post and may also want to hold responsible the entity against whom they have sought redress.

For more information on this Regulation or any ISDS related issues, please contact Matthew Weiniger, Partner, Joanne Greenaway, Professional Support Lawyer, or your usual Herbert Smith Freehills contact.