By Claudia Wortmann^[1]

State Parties to the United Nations Framework Convention on Climate Change (‘UNFCCC’) and the 2015 Paris Agreement are obliged to take steps to mitigate climate change. Such steps include achieving an urgent energy transition away from fossil fuels toward more renewable, ‘green’ energy. However, one of the issues that arises in the context of an energy transition is the obligations concurrently owed by States to foreign investors under investment treaties. In my article “Conflicts between international climate law and investment arbitration: A proposed exception to the full reparation standard without moving the goalposts” (JWIT 25:5-6, 2024), I explore how obligations owed by States under investment treaties can conflict with international climate law obligations. Foreign investors can seek damages for State actions which infringe on their rights under investment treaties, and this includes actions that were taken in furtherance of international climate obligations. This has resulted in criticisms levelled at investment law generally. In this post, I put forward one possible way to solve this conflict: an exception to the full reparation standard in the awarding of compensation and damages.

State Responsibility and the full reparation standard

In the process of seeking compensation and damages for breaches of an investment treaty, investment tribunals follow a number of codified and customary rules. One such rule is the full reparation standard, which provides that when a State commits such a breach, it ‘must, as far as possible, wipe out all the consequences of the illegal act and re-establish the situation which would, in all probability, have existed if that act had not been committed’. The doctrine, adopted from the early 20^th century inter-State Factory at Chorzόw case and has since been codified in the ILC Articles on Responsibility of States for Internationally Wrongful Acts ILC Articles. The full reparation standard is part of the doctrine of State Responsibility, an important aspect of public international law designed to ensure that States which breach international law are held responsible for their actions.

The full reparation standard has become synonymous with compensation and damages in investment arbitration, and its application has led to leading critics from academia and practice condemning awards of damages for being excessive or crippling, contributing to the erosion of State autonomy. It is perceived that States are unable to regulate effectively without being subject to significant claims for damages from foreign investors whose rights are negatively impacted by such regulation. Within the energy sector, many cases have been brought against States for measures aimed at regulating renewable energy or reducing reliance on fossil fuels. In the EU, examples include two cases (now discontinued) against the Netherlands, Uniper and RWE, relating to regulations regarding the early decommissioning of foreign investor-owned coal-fired power plants, and two claims against Germany over regulations affecting a coal-fired power plant and the phase out of two nuclear power plants. Such cases suggest that States are being discouraged from regulating in the energy sector where foreign investors are active, with concerns that regulation in the sector runs the risk of attracting arbitration claims. This has led to a normative conflict between investment law and climate law.

Some proposed solutions – which I explore briefly in the article – include shifting customary norms, amending investment treaties by way of carve-outs or exceptions, or removing investment treaty protections for foreign investors. In the context of arbitration, other proposals include making climate change regulation wholly non-compensable, or limiting compensation for climate change regulation based on considerations of proportionality, equity, or avoiding unjust enrichment. However, while each approach may create more regulatory space for States in the future, none can effectively limit compensation for climate change regulation in an immediate way. Even more important is that such a method or approach is accepted and adopted in the practice of investment arbitration. The urgency of climate change demands immediate action by States, as do international climate law instruments like the Paris Agreement. So, what options are available in the short term?

Article 55 ILC Articles exception: lex specialis

Based on the need for an immediately applicable exception to the full reparation standard, and one which will be accepted and applied by investment tribunals, an exception under Article 55 of the ILC Articles is suggested to be adopted. Article 55 provides for a lex specialis exception, which means that the ILC Articles (including the codification of the full reparation standard) do not apply to the extent that specific rules governing an issue exist.

Importantly, under the Article 55 the lex specialis exception is two-fold; it can either replace the conditions for the existence of an internationally wrongful act (a ‘strong’ exception), or the content or implementation of State responsibility once an internationally wrongful act has been found under the general rules (a ‘weak’ exception). A strong exception would require a significant departure from accepted practice, a replacement of generally applicable law under an investment treaty and customary international law, and an approach that is unlikely to be accepted by actors in the investment regime. Alternatively, applying a ‘weak’ exception, regarding either the content or implementation of an applicable rule, would allow for a limited derogation from the full reparation standard in disputes over climate change regulation, insofar as special rules on climate change regulation apply to the situation. In the article I outline the necessary pre-conditions to a finding of a lex specialis exception of this nature, including legal rank and specificity, and find that such an exception under the Paris Agreement can indeed exist.

There are certain pre-conditions that must be met for the exception to be applicable. These include that a State must be a Party to the Paris Agreement, and must develop and publicly state its own specific targets pursuant to Article 2 of the Agreement, for the direct purpose of meeting the objectives of the Agreement. Such a public declaration may include Nationally Determined Contributions (NDCs), which, while not legal binding on their own, can serve to create legal obligations and trigger State responsibility to uphold them. A State can then be held responsible for failing to comply with those proclaimed obligations. Consider then, if a State, in taking steps to achieve these specific targets breaches the standards of protection owed to a foreign investor pursuant to an investment treaty, then the State is still responsible for the breach of investor protection. However, at the crucial stage of awarding compensation, the general rule for awarding damages in line with the full reparation standard may be displaced, because the action which caused the breach was necessary to comply with the specific climate rules publicly declared by the State under the Paris Agreement.

Applying the Article 55 ILC Articles exception: Rockhopper v Italy

Let us consider the practical significance of this exception. Rockhopper v Italy, is a good example to illustrate how the conflict between foreign investor rights and climate action has played out on the international stage. The dispute centred around a 2015 law which banned offshore oil and gas production within a certain distance of Italian shores. The foreign investor intended to develop and produce energy from an oil and gas field off the Italian coast. After an exploration stage, in January 2016, Italy rejected the investor’s application for a production permit based on the 2015 ban, and the project never went into production. In a 2022 decision, the investment tribunal found that the ban had essentially expropriated the investor’s right to a production permit, and consequently awarded the investor roughly EUR 240 million in damages.

For the purpose of applying the exception in this example, it must be assumed that the relevant preconditions relating to the Paris Agreement above would have been in force at the time the dispute began.

1. Instead of enacting a ban, the production permit could be denied on grounds that approving it would breach Italy’s obligations under the ‘special rules’ pursuant to Article 2 of the Paris Agreement, triggered by public declaration (NDCs).
2. The investor could still bring a claim to an investment tribunal for the denial of the permit, and a tribunal would still likely find that Italy was in breach of the relevant investment protections owed to the investor.
3. Importantly, when determining the compensation due to the investor for the breach, the tribunal would be required to acknowledge the conflict between the investment treaty protections and the special climate rules pursuant to Article 2 of the Paris Agreement. It could then be argued that, to the extent that the State was taking steps to comply with these special rules, the exception in Article 55 was triggered.
4. This could then displace the full reparation standard insofar as the damage caused by the rejected permit application was required by those special rules. This would also allow the tribunal to exercise discretion and not be obliged to award damages to the full reparation standard.

It is very important that, for this exception to apply, States must have publicly stated NDCs pursuant to Article 2 of the Paris Agreement which form the basis for a State action which results in a breach of the rights of a foreign investor. In absence of any of these preconditions, the exception will not apply.

Conclusion

The Article 55 exception to the full reparation standard may help resolve the complex conflicts between investment protection and climate regulation, and it has the capacity to address the issue of excessive or crippling awards of damages in the short term. It can help States achieve climate regulation targets without the threat of significant damages awards, as long as the criteria above are met. However, it is not a long-term solution, and more conscious, future-proof reforms are needed to resolve the broader normative conflict. For now, though, the exception provides a mechanism for resolving conflicts faced by States that lead to negative outcomes like excessive compensation and regulatory chill in the overlap of investment law and climate law in the immediate future, while we await more comprehensive long-term reforms.

1. Claudia Wortmann, Hasselt University, KU Leuven. Claudia is conducting her doctoral research at Hasselt University, in a joint PhD with KU Leuven. She is a qualified solicitor and has previously practiced law in Victoria, Australia. ↑