Legal Framework for Renewables: Fragile Background or Sound Bedrock?

by Iurii V. Rybak, Volodymyr V. Yaremkо

For the past decade, the renewable energy sector has firmly become one of the most fast-growing and attractive spheres for investment projects around the globe. Even having a long pay-off period, renewable energy sources have shown their immeasurable potential to growth along with promising lucrative level of returns for the investors. Simultaneously, given the significance of initial capital contribution accompanied by low energy prices, governments were struggling to encourage foreign investment into renewable energy sphere by enacting a variety of support schemes, subsidies and economic incentives for the investors. To that matter the “feed-in tariffs”, special taxation and customs duties regimes, green bonds and government-funded loans with low interest rates have been enshrined in internal laws of states in order to maintain the confidence of the investors in their fulfillment.

Ultimately, extensive government support resulted in a relative boom of renewables over 2005-2015 with unaffordable to some states budget spending during a period of economic recession. This in turn pushed governments with an economically troubled situation in countries like Spain, Italy and Czech Republic into reducing or eliminating the previously promised level of support. Hence, such an unpredictable for investors step has raised the issue of investor’s legitimate expectations from the state, which consisted in retaining the legal framework unchanged. This has even variously defined in arbitration, and practitioners are almost unanimous in delineating the legitimate expectations of investor as forming the part of “fair and equitable treatment” of the investors by the host state and the award in Técnicas Medioambientales Tecmed, S.A. v. The United Mexican States (ICSID) illustrates this trend.  

“Pyrrhic victory” of the state?

As a matter of fact, based on the reason mentioned above, a number of states have been threatened or even faced investment arbitration claims brought by investors. To this point, investors to Spanish renewable energy sphere have initiated twelve known arbitration disputes as a result of the introduction of new measures which considerably modified the “feed-in tariff” regime. In order to curb costs, the Czech Republic has imposed retroactively its “solar tax” in claw-back legislative provisions that led to at least seven investment disputes being brought by investors against the state. After introduction of “Spalma incentive” decree with both future and retroactive effects that was aimed at reducing the subsidies to photovoltaic plants, Italian government have been threatened with several arbitration claims which resulted in recently declared withdrawal of Italy from the Energy Charter Treaty (“ECT”). Also, the latest news about Spanish energy company Gas Natural Fenosa, which intends to initiate ICSID arbitration against Colombia, serves as a good example of such a trend. Remarkably, the arbitration practice has formed set of cases with regard to investment energy assets, but investment treaty arbitration disputes in the renewable energy sphere is a relatively new category for this practice.

Factual matrix in Ukrainian renewable energy sector

In hindsight, in 2009, in order to trigger operation and encourage development of renewable energy sources in Ukraine, the country’s Parliament enacted special laws on introducing long-term “green tariffs” that have more common definition as “feed-in tariffs” in the energy industry. Such a step became crucial for strengthening foreign investments into that sphere as the attractive rates of “feed-in tariffs” along with corporate income tax and customs duty exemptions pushed investment plans ahead.

Regretfully for the industry, the Ukrainian unified electricity system has faced considerable problems over the crisis period in 2014, which that sequentially caused electricity supply problems. Furthermore, aside from its political crisis and military activities, Ukraine has run into deep economic recession with significant cuts in budget spending. The alternative energy industry has suffered a big portion of national problems after the halt of purchasing electricity from renewable energy installations located in Crimea and following the approval of temporary emergency measures in the electricity market, the national authorities of Ukraine have likewise substantially reduced previously guaranteed rates of “feed-in tariffs”. It is worth mentioning that in addition to reducing the formerly secured level of investors’ income, the state has also decided to cancel the previously introduced exemption of corporate income tax levied on income from the sale of electricity generated from renewable sources till 2021. It also canceled other taxation benefits such as reduced land tax for electric power enterprises from renewable sources.

Foreshadow of new investment disputes against Ukraine?

As Ukraine has not been completely under the radar in the development of renewable energy sources with foreign investments, is there a chance it will face the same type of disputes? Presumably, given the magnitude of the situation, Ukraine may have completely ignored the investment protection mechanisms with legitimate investor’s expectations among them. For those investors that have successfully deployed or intended to maintain their renewable investment project in Ukraine, the situation may be hazardous, as previously estimated lucrative business plans may essentially be crushed by enacted laws. Consequently, such type of behavior employed by the state may lead to arbitration disputes lodged by foreign investors in Ukraine’s renewable energy industry.

Once Ukraine has become a member of ECT, a huge segment of investors rights were guaranteed by the state of Ukraine. Therefore, special legal consideration shall be given to the issue of convergence of national laws with the provisions of international treaties. As preliminary analysis shows, the actions of Ukraine may diverge with ECT provisions so that there could be grounds for investigating the breach of investors’ rights by the state. Essentially, Ukraine could not just gloss over its own actions, which in their substance might breach investors’ legal expectations on behalf of the state.

“State of necessity” defense?

As the actions of Ukraine with regard to foreign investors in 2014 have been induced by emergency measures in the economy and energy spheres, can the “state necessity” be an objective ground that justifies state actions? The lack of uniform arbitral practice on “state necessity” defense that is occasionally used in investment arbitration could not possible ensure a correct suggestion about the legality of the Ukrainian state’s actions towards a foreign investor in the renewable sphere.

By its nature the “state necessity” measure can be employed by the state in order to protect public order and basic functioning by the state. Argentina’s economic crises in 2001 and following disputes brought by foreign investors against the state could exemplify how “state necessity” might be used in order to justify state actions. At the same time, cases like CMS, Total and Sempra vs Republic of Argentina have shown general unwillingness of arbitral tribunals to accept this argument. When addressing this issue, diligent interpretation and analysis of interaction between customary international law, bilateral and multilateral investment treaties as well as national laws of the state have to be conducted.

Acceptance of risk and “police powers” of the state

On the outset of investment project there should be a portion of risks presumably considered by the investor that the legal grounds for doing business in the state may be changed over the period of functioning of investment. Depending on the time when investments were actually made, reasonable expectations on the part of the investor may vary. Be that as it may, with the Ukrainian case there could be strong grounds to presume that the type of actions employed by the state may not generally be predicted by a prudent investor. Hence, it stirs up debates on another interrelated issue of whether such drastic changes in national legislation applicable to investments have to be deemed as the ordinary right of the state to regulate, so-called “police power” of the state? In order to address this issue the balance of interests between the state and foreign investor should be considered.

To that matter, the recently resolved case of Charanne B.V, & Construction Investments S.A.R.L vs The Kingdom of Spain (SCC) shows the level of complexity of issues as to the breach of investors’ legitimate expectations opposed by the sovereign right of the state to regulate. This case was brought by investors from the Netherlands and Luxemburg who have invested in the photovoltaic sector in Spain and suffered losses following dramatic changes in Spanish legislation. Notably, the Spanish authorities were creative enough when instead of reducing the applicable “feed-in tariffs” in the renewable energy industry, they introduced an annual cap on the number of hours the investor could sell electricity for benefiting tariffs. Ultimately, the tribunal was not swayed by the arguments of claimants on breach of its own legitimate expectations and rejected the claim. Nonetheless, the ratio of the case that might also be considerate to the situation with Ukraine consists in a conclusion that unless specific commitments have been given meeting fair and equitable treatment and, therefore, investors legitimate expectations under the ECT do not mean to freeze the legal framework or through these means to substitute stabilization clauses.  

What conclusions can be derived?

In a nutshell, Ukraine could potentially face the same type of international investment disputes due to the actions employed by the state over the last few years. If the government’s plan was about to outsmart investors in the energy industry, such intentions may be smashed by the availability of investment protection mechanisms. At the same time, the issues of investors’ legitimate expectations along with stable and predictable legal framework for business are at a high value when deciding to implement a particular investment project. The provisions of Ukrainian laws on protection of investments as well as on renewable energy sources are far from being identified as having a state-of-the art approach in protection of investors’ legitimate expectations and any improvements made to that point have a rather piecemeal approach. Accordingly, separate legal instruments like stabilization or economic equilibrium clauses are recommended in order to guarantee investors’ interest in renewable energy projects and stability of applicable legislation.