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Right to Regulate vs Acquired Rights


  • 28 october 2019
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Guy Block (Partner), Christophe Rolain and Elvira Saitova (associates) have written on "How to Ensure the Success of Energy Projects by Making Outcome of Arbitral Disputes More Predictable" in a recent article published by The Legal Herald. You can download and share the full article by clicking on the link below or read it quickly on our website.
Right to Regulate vs Acquired Rights


Energy law contains numerous examples of tensions between a State’s right to regulate and the investors’ acquired rights. In every energy contract, public and private interests must be protected. The difficulty lies in the balance between the protected interests, predictability and regulatory risk. 

1. From right to regulate to existence of ‘regulatory risks’ 

In TTIP1 or CETA, “rights to regulate” are expressly included and some international treaties set certain limits. The imposed “limits” on the right to regulate are often in relation to expropriations or quasi-expropriations. 

Arbitral case law recognises States’ right to regulate. It is expected that a State hosting investments will act in a “logical, unambiguous and transparent manner” so that the investor can identify the appropriate direction in the State’s policy regarding its own investments. 

In Enron v Argentina,  the arbitral tribunal adequately recalls the principle that stability does not mean “freezing” of the legislative system or “loss” of a State’s regulatory power that should be linked to the ‘stabilisation” clauses examined below.

On the other side, any investor is deemed to have analysed the “regulatory risk” before investing. In Charanne’s case, the tribunal rejected investors’ claim on the ground that "in order to make a reasonable investment decision, the claimants should have performed an analysis of the regulatory environment. Such an analysis would have revealed that the introduction of changes to the subventions in later years was highly probable”. 

This “regulatory risk” is also used to assess if the principle of reasonable and legitimate expectations have been violated, especially in the case of quasi-expropriation. 

In Starett Housing Corp v In Iran,  for example, the court held that: 

“Those who invest in Iran, like those who invest in any other country, must bear the risk of seeing the country affected by strikes, lockouts, unrest, changes in the economic and political system and even a revolution. If any of these risks materialise, it does not necessarily mean that the property rights affected by this type of event can be considered as having been usurped.” 

Zero regulatory risk does not exist and the investor is expected to assess it case by case. However, such risk can be mitigated through “stabilisation” clauses. 

2. Attempts to limit regulatory risk through ‘stabilisation’ clauses

 Stabilisation clauses are intended to maintain the famous “balance” of relations between the parties. Their primary purpose is to limit the regulatory risk that weighs on any investor. By the insertion of such clauses, the State is allowed to make regulatory changes as long as the economic benefit for the investor is maintained (“Economic Equilibrium clause”) or the State commits not to modify the legislation in place at the time of investment or that the effect of the new law will not apply to the investment made (“Freezing clause”). Such clauses can be very general or very specific (taxation, import or export duties, employment or environmental law).

Stabilisation clauses differ from intangibility clauses preventing the State from using any national rules allowing to unilaterally change the agreement’s terms and from freezing clauses. 

Some arbitral awards rely on the absence of stabilisation clauses in order to draw conclusions — often negative — at the expense of investors. In the Charanne case, the arbitral tribunal relied in particular on the absence of a stabilisation clause to base its reasoning on regulatory risk-taking in Spain, in this case the change in the support regime for renewables. Similarly, in Enron v Argentina and Parkenings v Lithuania, 16 the arbitral tribunals had firmly recalled States’ right to regulate — i.e. the nonlegislative freeze — arguing that it would have been otherwise in the presence of a stabilisation clause: “The Rule (or right to regulate) is valid unless the state and the investor enter into an agreement including a so-called stabilisation clause which freezes the legal regulation as at the day of allowing investment”. 

It should be noted that such stabilisation clauses are not applicable when a state is not a party to the agreement with the investor and are sometimes considered unconstitutional as a government cannot alienate a legislative power it does not have.

 A stabilisation clause cannot also prevent a state from a lawful indirect expropriation, nor a direct expropriation unless the clause expressly considers that situation. Even in this situation, the remedy is still a financial compensation.

 Finally, such clauses can be found contrary to international environmental or human rights treaties thus not enforced by the courts or arbitration panels. Since such clauses are part of States’ sovereignty, they should be written as specific as possible with regards to the particular act of the state party being precluded or restrained in the clause, linked to an international arbitration clause and if possible, the applicable law is not the one from the State party to the agreement. 

To alleviate concerns regarding the enforceability of a stabilisation clause, a State may unilaterally provide similar guarantees by means of a global Investment Code or a legislation specifically designed for a particular sector such as electricity, or gas. However, it should be noted that a State will still have the right to change such laws and regulations. Therefore, the question of a potential breach of the investor’s legitimate expectations arises.

3. Limits of a host State's right to regulate and investor's legitimate expectations 

Over the years, arbitral jurisprudence has established certain criteria to determine how far the State can go in its right to regulate and therefore how far the reasonable and legitimate expectations of investors can go. Several tests can be drawn from this case law, namely: 

(a) The existence or name of promises, guarantees or assurances (representation and insurance) from the host State (Saluka Test);

(b) The "drastic change" test in relation to the ordinary regulatory risk at the time of the investment;

(c) The test of excessive profits (luxury profits). 

Behind each of these criteria or tests is the economic calculation — the famous balance — that justified the decision to invest

4. Legal recognition of acquired rights: ‘Grandfathering Clauses’

The State can also take the initiative to include in its legislation certain provisions designed to maintain a balance with investors, whether national or international, in the event of a fundamental change or disruption in the system through the “Grandfathering Clauses and other provisions for the maintenance of effects”.

Typically, grandfathering clauses are used to maintain acquired rights prior to the adoption of a new law or the opening of a market. It repeats the “previous or historical agreements” that are valid, notwithstanding the new regulations. Only new constructions are subject to the new law.

A good example can be found in the recent opening of the West African electricity market (WAPP) where a resolution of the ERERA authority expressly provided for the continuation of the effects of bilateral (electricity) power purchase agreements notwithstanding the entry into force of the opening of the electricity market.

However, exceptions are provided for to this prior art, in particular with regard to unused capacities. Such a rule was also applied in Europe in the aftermath of the liberalisation of the gas market26 for long-term supply contracts. 

About the authors

Guy Block(g.block@janson.be) is a partner, and Christophe Rolain (ch.rolain@janson.be) andElvira Saitova (e.saitova@ janson.be) are associates, at the Janson law firm’s Energy & Infrastructure department.

This article was originally published in the Legal Herald the legal journal created by Lee Hishammundin Allen & Gledhil a fellow member of the Interlaw Network.


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