The European Court of Justice renders its opinion on the EU-Singapore free trade agreement: investment chapter is not within EU's exclusive competence

On 16 May, 2017 the European Court of Justice (the Court) rendered its Opinion on the competence of the European Union to conclude the Free Trade Agreement (FTA) with Singapore. The Opinion recognises exclusive EU competence over most of the agreement and largely settles a long-standing dispute between the Commission and the Member States on the division of competences under the Lisbon Treaty.

Importantly, in the context of investor-state dispute resolution, the Court's Opinion is likely to render any agreement including protection for non-direct foreign investments or investor-state dispute settlement (ISDS) provisions a so-called "mixed agreement" which requires each of the Member States as well as the EU itself to become party, unless certain aspects commonly found in such agreements are removed or the Member States otherwise agree (discussed further below).  

The Opinion will have a major impact on the negotiation of future EU trade agreements, whether pending or anticipated (including the potential FTA between the UK and the EU following Brexit).

1. Background

The EU-Singapore FTA (EUSFTA) was negotiated by the European Commission between 2010 and 2013. The Commission designed it as an agreement that could be entered into by the EU alone, without the lengthy delays and complications that can arise if it also needed to be entered into by each of the 28 Member States in their own right, requiring ratification under 28 different internal constitutional procedures (including potentially the approval of regional assemblies such as that of Wallonia, Belgium).

It is in fact the first FTA to be considered by the Court since the entry into force of the Lisbon Treaty. Article 207 of the Treaty on the Functioning of the European Union (TFEU) resulting from the Lisbon Treaty extended the exclusive powers of the Union to conclude trade agreements so as to include all services, foreign direct investment (FDI) and trade related aspects of intellectual property rights (IPR). Article 3(2) TFEU also formally recognises the exclusive competence of the EU to conclude agreements in other areas, including where the agreement would affect common EU rules or alter their scope.

However, the Member States disagreed that the envisaged EUSFTA fell entirely within exclusive EU competence and insisted on becoming parties to the agreement. To resolve the matter, the Commission referred the issue to the Court using the procedure provided for in Article 218(11) TFEU.

2. The AG Opinion

Advocate General Sharpston QC (the AG) gave her non-binding opinion to the Court on 21 December 2016 which is discussed in our blog post here.  In brief, she concluded that while the Union had non-exclusive competence to conclude all parts of the agreement except those on the termination of the bilateral investment treaties with certain Member States, it did not have exclusive competence to conclude those aspects that concerned maritime and air transport, non-FDI investment (e.g. portfolio investment), non-commercial IPR aspects or labour/social policy and environmental standards and that therefore the Member States were entitled to become parties (making the FTA a so-called mixed agreement).

3. The Opinion of the Court

The Court went further than the AG in recognising the exclusive competence of the EU to enter into most of the commitments in the agreement. In particular it found that the EU has exclusive competence to conclude the agreement in respect of all aspects of transport on the basis that these could affect common rules or alter their scope to a sufficient degree. The Court also found that the EU has exclusive competence to enter into the commitments on all aspects of intellectual property included in the agreement and also those concerning sustainable development and environmental protection since they were sufficiently linked to the objective of liberalising trade. It agreed however with the AG that there was no exclusive competence to undertake commitments in respect of non-direct foreign investment in the absence of rules in EU legislation that would be affected.

Substantive protections: EU has exclusive competence in relation to FDI

Article 207(1) TFEU provides that EU acts concerning FDI fall within the common commercial policy and draws no distinction between whether those EU acts concern the admission or protection of such investments. The Court found that, whilst the protections in the relevant part of the Investment Chapter (Section A of Chapter 9) do not relate to the admission of investments, this does not preclude those protections falling within the common commercial policy where "they display a specific link with trade between the European Union and that third State".

The Court then concluded that the substantive rules protecting investments in Section A of Chapter 9 fall within the common commercial policy, in so far as they relate to FDI between the EU and Singapore. Conclusion of such protections was therefore within the EU's exclusive competence so far as those provisions relate to FDI.

However, considering the definition of investment contained in the draft text (Article 9.1), the Court found that it was clear that Chapter 9 relates to both direct investment and any other type of investment.  Non-direct foreign investment is quite clearly excluded from Article 207(1) TFEU and therefore not within the "common commercial policy".

The Court concluded that the EU does not have exclusive competence to conclude an international agreement with Singapore in so far as it relates to the protection of non-direct investments, as it could find no other basis for it to do so. Therefore, Section A of Chapter 9 of the EUSFTA cannot be approved by the EU alone and must be approved by the Member States.

Termination of Member States' bilateral treaties with Singapore

Article 9(10) of the EUSFTA provides that: "Upon the entry into force of this Agreement, the [bilateral investment] agreements between Member States of the Union and Singapore … including the rights and obligations derived therefrom, shall cease to have effect and shall be replaced and superseded by this Agreement".  

The Court found that the EU has exclusive competence to conclude a provision of an agreement with a third party state which stipulates the termination or replacement of commitments concerning direct investment contained in bilateral treaties existing between that third party state and Member States. This is because (i) the EU takes the place of the member states when it negotiates and concludes international agreements relating to a field in which it has exclusive competence; and (ii) the EU has exclusive competence regarding FDI.

Therefore, Article 9.10 falls within the exclusive competence of the European Union in so far as it relates to the commitments concerning FDI contained in the bilateral investment agreements concluded between Member States and the Republic of Singapore. To the extent that Article 9.10 relates to commitments in pre-existing bilateral investment agreements relating to non-direct investment, there is, however, no exclusive competence. 

Investor-State Dispute Settlement

Another surprising element of the Opinion is the finding that Investor-State Dispute Settlement provisions cannot be agreed by the EU alone. The Court analysed the dispute resolution provisions, noting that (i) both individual Member States and the EU can be party to arbitration proceedings to determine investors' claims under Chapter 9; (ii) a Member State gives consent to arbitration which is subject to withdrawal of "'any pending claim submitted to a domestic court or tribunal concerning the same treatment as alleged to breach the provisions of Section A (Investment Protection)’"; and therefore (iii) whilst a claim against a Member State may proceed in that Member State's domestic court, this is within the discretion of the investor claimant.

The competence of the EU to enter into international commitments includes competence to couple those commitments with institutional provisions of an ancillary nature to the substantive provisions which they accompany. However, for the reasons described above, the dispute resolution regime included in the EUSFTA removes disputes from the jurisdiction of the courts of the Member States and could not be described as ancillary to the provisions of the agreement which fell within the EU's exclusive competence. The Court concluded that the investor-state dispute settlement provisions therefore fall within the shared competence of the EU and the Member States.

4. Comment

The long-awaited Opinion clarifies the law in this area, and the Court has taken a broader view of the scope of exclusive EU competence than the AG.

The immediate consequence of the Court's decision is that all of the EU's FTAs and other international agreements will be mixed agreements when they include (i) investment protection provisions which are sufficiently broad to protect non-direct investment; and/or (ii) investor-state dispute settlement mechanisms which may remove resolution of disputes between Member States and foreign investors from Member States' domestic courts.  Moreover, the Court's reasoning would apply to the EU's proposed Multilateral Investment Court System (described in our blog post here) in the same way that it applies to resolution of investor-state disputes by arbitration. 

Ratification of such international agreements by all Member States will inevitably be a longer and more difficult process than if they fell within the EU's exclusive competence. Such agreements are susceptible to domestic political feeling within each Member State, as was seen recently, for example, with the issues in the Wallonia Regional Parliament over CETA (see our previous blog post here), and in the Netherlands over the EU-Ukraine FTA.  One way around this, which could help avoid these delays and complications, would be for the EU to reconsider the content of its FTAs and avoid the inclusion of non-direct investment, or ISDS provisions, in order to facilitate conclusion by the EU alone. This would be a major change in its current policy and it is not clear whether it would be contemplated – another possible option might be to adopt ISDS as a standalone protocol, subject to separate conclusion and approval, but this could leave investors without separate protection in the interim.

The Opinion could also have relevance in the Brexit context. Should the EU decide to take this step and avoid the inclusion of the areas of non-exclusive competence, this could help the UK to achieve its objective of a "new, comprehensive, bold and ambitious" FTA with the EU following Brexit, that would not require ratification by each Member State and so may be less vulnerable to national politics across the EU.  

As noted, however, this would mean the removal of ISDS. The UK's Brexit White Paper provides little detail on the UK Government's strategy with regard to investment protection (see our blog post here).  However, if the UK and/or the EU do propose inclusion of substantive investment protections affecting non-direct foreign investment and/or ISDS in an EU/UK FTA, and the White Paper seems clear that at least the latter is being considered, this "EU-only" approach would not be possible. And, of course, other agreements will be envisaged in the context of the whole exit package which will inevitably require the participation of all Member States.     

For more information, please contact Lode Van Den Hende, Partner, Andrew Cannon, Partner, Iain Maxwell, Of Counsel, Eric White, Consultant, Hannah Ambrose, Professional Support Consultant, Vanessa Naish, Professional Support Consultant or your usual Herbert Smith Freehills contact.