ECJ Clarified Article 307 EC Treaty: BITs with Non-EU States Concluded Prior to Accession to the EU Supersede EU Law in Case of a Conflict

On 15 September 2011, the Court of Justice of the European Union (the “Court”) issued the judgment in case C-264/09 (Commission v. Slovak Republic) (the “Judgment”).

The Court made an important clarification with respect to relevance of Article 307 EC Treaty, dealing with treaties concluded by EU members with non-EU members (the “Third States”) before accession to the EU, to bilateral investment treaties (the “BITs”).

Underlying Dispute

The underlying dispute was based on the contract entered into in 1997 by Aare-Tessin AG für Elektrizität (“ATEL”) (Switzerland), and Slovenské elektrárne a.s., (Slovakia), whose successor was Slovenská elektrizačná prenosová sústava, a.s. (“SEPS”), the Slovak electricity transmission system operator (the “Contract”).

Under the Contract, SEPS granted ATEL a guaranteed right of 300 MW of transmission capacity between Poland and Hungary from 1 October 1998 to 30 September 2014. This right of transmission was reserved for ATEL in consideration of its financial contribution to the construction of the said transmission line. This financial contribution represented more than 50% of the construction costs.

On 14 July 2009, the Commission brought an action against the Slovak Republic under Article 226 EC with the request to the Court to “declare that, by failing to grant non-discriminatory access to its transmission system, the Slovak Republic has failed to fulfil its obligations under Articles 20(1) and 9(e) of Directive 2003/54/EC of the European Parliament and of the Council of 26 June 2003 concerning common rules for the internal market in electricity and repealing Directive 96/92/EC.”

Directive

Article 9(e) of the Directive provides as follows:

“Each transmission system operator shall be responsible for:…

(e) ensuring non-discrimination as between system users or classes of system users, particularly in favour of its related undertakings.”

Article 20(1) of the Directive provides as follows:

“Member States shall ensure the implementation of a system of third party access to the transmission and distribution systems based on published tariffs, applicable to all eligible customers and applied objectively and without discrimination between system users.”

The Slovak Republic relied on Article 307 EC Treaty which established the primacy of the treaties entered into by EU members with Third States prior to the accession to the EU in relation to the EC Treaty. The wording of the underlying provision is as follows:

“The rights and obligations arising from agreements concluded before 1 January 1958 or, for acceding States, before the date of their accession, between one or more Member States on the one hand, and one or more third countries on the other, shall not be affected by the provisions of this Treaty.

To the extent that such agreements are not compatible with this Treaty, the Member State or States concerned shall take all appropriate steps to eliminate the incompatibilities established. Member States shall, where necessary, assist each other to this end and shall, where appropriate, adopt a common attitude…”

Arguments

The Slovak Republic argued that the Contract is not a contract for preferential access but an investment contract and the right of transmission is one specific means by which ATEL may recover its investment. The withdrawal of the guarantee would result in discrimination against ATEL compared to other operators in the market had not made an investment in the Slovak transmission system. Such an act by the Slovak Republic would mean depriving ATEL of its rights without appropriate compensation, which would be not only in breach of the Contract but also of the Energy Charter Treaty (the “ECT”) which forms an integral part of Community law.

Consequently, the interpretation of the Directive put forward by the Commission would entitle ATEL to argue that the withdrawal of the guarantee of the right of transmission, without payment of an appropriate compensation, infringes the provisions governing expropriation (Article 13 ECT), the right to fair and equitable treatment (“FET“) (Article 10 ECT) or the clause of the Contract (last sentence of Article 10(1) ECT). It would also constitute a breach of the FET obligation under Article 4(2) BIT between the Swiss Confederation and the Czech and Slovak Federative Republic (the “BIT”). Alternatively, even if the withdrawal were made under the procedure constituting a lawful expropriation, the Slovak Republic would still be under an obligation to compensate to the investor.

The Commission’s position was that a breach of the Directive cannot be justified by reliance on the first paragraph of Article 307 EC Treaty, because this provision applies only where Community law is incompatible with prior agreements. However, according to the Commission, there is no incompatibility between the BIT and Community law in the present case. Moreover, the BIT in no way obliges the Slovak Republic to maintain the Contract and it is entitled to terminate it in order to comply with the obligations under the Directive. The right to terminate the Contract also stems from the lack of a provision in the BIT stipulating that the Contract must be performed up to its expiry date of 30 September 2014.

Decision

The Court sided with the Slovak Republic that due to Article 307 EC Treaty, as the BIT was concluded prior to the Slovak Republic’s accession to the EU, even if preferential access is incompatible with the Directive, it was justified as long as it was based on the obligation under the BIT.

To reach this conclusion, the Court had to find that the preferential access granted to ATEL had to be considered as an investment covered by the BIT. In this context, the Court emphasized that it is not in the position to interpret the BIT. However, it was its duty to examine the factors which make it possible to determine whether the BIT imposes an obligation on the Slovak Republic which cannot be affected by the EC Treaty, within the terms of the first paragraph of Article 307 EC Treaty. Based on the definition of the BIT, the Court decided that there was an investment.

The Court stated that according to settled case-law, first paragraph of Article 307 EC Treaty exists to clarify, in accordance with the principles of international law, in particular, with Article 30(4)(b) Vienna Convention on the Law of Treaties, that the application of the EC Treaty does not affect the duty of the EU member state to respect the rights of non-member countries under a prior agreement and to perform its obligations. Furthermore, it is necessary to establish that another party to an earlier agreement of a state will still be entitled to require performance.

The Court also noted that in the context of Article 307 EC Treaty, an EU member state has a choice to take appropriate steps to eliminate incompatibilities between an earlier treaty and the EC Treaty. Wherever possible, a member state should make adjustments to accommodate Community laws, even if such adjustments would be a denunciation which is nevertheless possible only if the agreement in question contains a possibility of denunciation. Absent a denunciation clause, a party would “breach the rights” of the other party by denunciation.

However, in this case the Contract did not contain such a denunciation clause. So the Slovak Republic did not have the opportunity to denounce in order to accommodate EU law.

The Court agreed with the Slovak Republic that termination of the Contract would have the same effect as expropriation under Article 6 BIT. The fact that the Slovak Republic could pay compensation does not have the effect of cancelling the Slovak Republic’s obligation not to take expropriatory measures against investments protected under the BIT. The Slovak Republic was only required to use legitimate means to comply with EU law.

The Court ultimately concluded that even if it were to be assumed that the preferential access granted to ATEL were not compliant with Directive 2003/54, it was still protected by the first paragraph of Article 307 EC Treaty. The action of the Commission was, therefore, dismissed.

Summary

The Judgment must be regarded as a good news for investors from non-EU countries since it is now clear that, based on the first paragraph of Article 307 EC Treaty, they remain under protection of BITs concluded by EU states before they were granted this status even if benefits conferred on such investors and protected under the applicable BIT are in conflict with the EU law. However, denunciation clauses in the contract underlying an investment, if they exist, trigger an obligation of a state to denounce such an agreement as an “appropriate step” in the context of Article 307 EC Treaty with a view to eliminate incompatibilities between an earlier treaty and the EC Treaty.