United States: Investment Disputes Arising From Regulatory Changes In Clean Energy

This is the fifth issue of WilmerHale's 10-in-10 Hot Topics in Energy Series. Over the course of 10 weeks, our attorneys will share insights on current and emerging issues affecting the US energy sector. Attorneys from across various practice groups at the firm will offer their take on issues ranging from congressional investigations, to the impact of key regulatory reforms, to emerging trends in domestic litigation and international arbitration. Read the first, second, third and fourth alerts in this series and our other recent publications.

Clean energy is a growing market. According to some estimates, global clean energy investment reached approximately USD 332 billion in 2018. Clean energy projects tend to be long-term and capital-intensive. Investors in clean energy thus often require a degree of regulatory stability. In some cases, they may also require economic incentives such as subsidies or long-term fixed tariffs. Governments often adopt clean energy regulations to address these needs and attract investment, but changes in market conditions, political alignments, or public opinion may lead to changes in the applicable regulations. These changes can, and often do, lead to disputes.

While domestic companies may be limited to challenging unfavorable regulatory changes in the local courts, investors from abroad may be able to seek remedies under international law. Many countries have entered into investment treaties that extend protections to foreign investments that may not be available under domestic law. For example, many bilateral and multilateral investment treaties include an obligation on signatory States to provide "fair and equitable treatment" (FET) to foreign investment. The FET obligation has often been interpreted to protect investments from the consequences of fundamental or unreasonable regulatory changes.

Many bilateral and multilateral investment treaties also allow an investor to bring a claim directly against the foreign host State in international arbitration. If the investor is successful, it will be entitled to compensation for any losses caused by the regulatory changes. Importantly, these treaties are generally not applied to restrict the ability of a host State to amend or rescind existing legislation; they generally provide a mechanism for investors to seek compensation for damage caused by breaches of the obligations imposed by the treaties.

We discuss below some examples of regulatory changes in the clean energy sector that have given rise to disputes, as well as several recent decisions by international arbitral tribunals in this context. We also identify other changes or proposed changes to clean energy regulations that could give rise to similar disputes in the future.

Investment Disputes Arising out of Changes to Clean Energy Regulations

Clean energy has become a major focus of regulatory efforts across the world. Those efforts have led to new regulations and sometimes to changes in existing regulations that affect the value of existing investments.

For example, in 2007, Spain implemented an incentive regime for renewable energies. The regime guaranteed the payment of feed-in tariffs for the lifetime of solar parks. Feed-in tariffs are a common incentive regime for the development of renewable energy projects that work by ensuring price certainty over time. Spain's feed-in tariff regime ultimately resulted in a tariff deficit, meaning that the subsidies the government was paying to the operators of the solar parks were higher than the end-price the government charged for that energy.

Spain gradually changed its regulatory regime. First it imposed taxes on electricity production in 2012; then it eliminated some subsidies in 2013. A completely new regulatory regime entered into force in 2014. The new regulations calculated reasonable rates of return based on the operational costs of "efficient" solar parks. The solar parks of many investors did not meet those requirements, and the investors argued that the new regulations effectively destroyed their investments because they would operate at a loss.

To date over 40 foreign investors have filed arbitration claims against Spain alleging that those regulatory changes violated Spain's commitments under various investment treaties. Below we address two awards in which tribunals addressed relatively analogous issues, but reached different conclusions.

In Eiser Infrastructure v. Spain, the arbitral tribunal found that Spain's regulatory changes violated the FET obligation under the Energy Charter Treaty (ECT), a multilateral treaty focused on protecting investments in the energy sector. The tribunal recognized that States have the right to regulate (including the right to change existing regulations). The tribunal, however, considered that the FET obligation in the ECT protected investors against what it characterized as "fundamental" and "unprecedented" regulatory changes that led to a "totally different" regulatory regime than the one in place when the investment was made, particularly when those changes had a significant negative impact on prior investments that had been made in reliance on the previous regulations.

In contrast, the tribunal in Charanne and Construction Investments v. Spain, another case under the ECT, reached a different conclusion. In that case, the investor had focused on the changes that preceded the general regulatory overhaul of the solar sector, such as the introduction of energy taxes. The tribunal held that those changes did not violate the FET obligation. The tribunal placed considerable weight on the fact that the investor's expectations were based on general regulatory provisions – not on specific contracts or representations. The tribunal concluded that a sophisticated investor could not have had any expectation that the regulatory framework would not change during the lifetime of a project.

Other European States, specifically Italy and the Czech Republic, made similar changes to their clean energy regulations and have also faced claims arising from those changes.

The tribunals that have addressed cases arising from Spain's, Italy's, and the Czech Republic's changes to their clean energy regimes have reached divergent conclusions. Some of those differences can be explained by the specific facts of each case and the particular treaty involved. However, some of the divergent results also reflect that different tribunals have taken different views regarding the content and scope of the FET obligation and the consequences States should face when they change the regulatory framework for energy projects in a way that hurts existing investments. Many of the tribunals that have decided these cases have agreed with the Eiser Infrastructure tribunal and have held that States must compensate investors when they change regulatory regimes that were adopted specifically to attract that investment.

These types of disputes are not limited to Europe. Another example relates to claims brought against Canada under the NAFTA based on changes to clean energy regulations, more specifically to the Ontario Power Authority's (OPA) wind power regulations and its feed-in tariff program.

In one case brought against Canada related to these regulations, Windstream Energy v. Canada, the investor had entered into contracts with the OPA to obtain feed-in tariffs for its offshore wind farm. The OPA later imposed a moratorium on offshore wind power generation. The OPA refused to renegotiate the contracts with the investor. Instead, it repeatedly represented to the investor that the moratorium on offshore wind power was only temporary. This situation lasted several years. The OPA refused to allow the investor to start operating the offshore wind farms under the contracts. It also refused to rescind the contracts.

The arbitral tribunal hearing the investor's claim under the NAFTA ultimately found in favor of the investor, holding that Canada had subjected the investor to a "legal and contractual limbo" and had thus treated it unfairly and inequitably in breach of the NAFTA.

In another case, Mesa Power Group v. Canada, however, a different tribunal reached a different result and ruled against the investor. The investor in that case argued that Ontario had arbitrarily introduced "buy local" requirements into its feed-in tariff program and that the introduction of such requirements was the product of undue political interference aimed at structuring the program for the benefit of certain companies. The tribunal acknowledged that Ontario's feed-in tariff program was subject to criticism; however, it concluded that those shortcomings did not meet the necessary threshold for finding a breach of the NAFTA. The crux of the tribunal's decision was that it considered that it had to afford "a good level of deference to the manner in which a state regulates its internal affairs."

Other Potential Changes to Clean Energy Regulations

States are continuing to regulate in the area of clean energy and will continue to do so in light of the importance of clean energy to their environmental and economic development goals. Some other regulatory changes that have been adopted or proposed in recent years include:

a. United States: there is a proposal to replace the United States' main climate change initiative, the Clean Power Plan (CPP), which was issued in June 2014. The CPP, which was intended to reduce pollution from coal-based power plants, incentivized clean energy generation. Specifically, the CPP gave individual states flexibility to meet environmental targets and particularly fostered the development of clean energy sources such as wind, solar, and hydropower.

The Trump administration has proposed replacing the CPP with the "Affordable Clean Energy" plan (ACE). ACE also aims to reduce reliance on fossil fuels, but its environmental standards are laxer than the CPP's. There is also less emphasis on incentivizing states to develop clean energy sources. In contrast, Congressional Democrats have recently announced another proposal, the "Green New Deal," which includes ambitious objectives for achieving net-zero greenhouse gas emissions and decarbonizing electricity, transportation, and industry.

b. European Union: in November 2016 the European Commission proposed a package of environmental measures known as "Clean Energy for All Europeans." The package is composed of eight pieces of legislation. Half of them have already been approved by the European Parliament. The other half is scheduled to be approved in the first half of 2019. The objectives of the package are for Europe to "achiev[e] global leadership in renewable energies" and to introduce a binding renewable energy target of at least 32% of total energy usage. The package also includes an emissions reduction target: the objective is to reduce emissions by 45% by 2030, relative to 1990 standards.

c. Taiwan: Taiwan has adopted ambitious goals to lead wind power development in Asia. It has projected that it would represent two-thirds of the sector's growth in Asia by 2020. In 2018, Taiwan announced that it would reduce the subsidized price it paid to offshore wind producers by 12.7%. In response to strong objections from offshore producers, Taiwan announced on 30 January 2019 that it would institute a lower price reduction of 5.7%.

d. Mexico: Over the past three years, Mexico has held annual auctions of renewable energy rights. The new administration of President Andrés Manuel López Obrador has shifted Mexico's policy priorities from renewable power generation to the development of natural gas and other fossil fuels. On 31 January 2019, Mexico cancelled a planned auction of renewable energy rights and indicated that it will hold no further auctions.

These examples illustrate the kinds of regulatory changes that States will continue to implement in the coming years. These kinds of changes can have profound effects on investment, both in terms of attracting new investment and in affecting the economic value of existing investment. Investors in long-term, capital-intensive clean energy projects may be able to protect their investments both by structuring those investments at the outset to attract the protections of investment treaties and by considering remedies under international law when regulatory changes like these harm the economic value of an existing investment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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