The new exclusive EU competence means that in the medium and long run the existing member state BITs will be successively replaced by European BITs or investment chapters in FTAs concluded by the EU with third countries (on the latter see Roger Alford’s entry). The EU Commission’s communication provides a vague sketch of what the EU’s policy in this respect may look like. What is more acute is the transitional period: what happens with the existing BITs and investment arbitrations in the meanwhile? These questions are addressed in the Commission’s draft Regulation. (For a more in-depth analysis of the Commission’s proposals see the LSE lead study commissioned by the European Parliament available here).

In a nutshell, the Commission proposes a “grandfathering rule” that would bring the existing BITs in conformity with the exclusivity of the new EU competence (Article 2(1) TFEU) by providing for an automatic authorisation for member states to maintain in force their BITs with third countries (NB: not intra-EU BITs which the Commission considers to be superseded by EU law, see Christophe von Krause’s entry) under the condition of notifying them to the Commission. While the authorisation would stem from Parliament and the Council, the powers to withdraw the authorisation for a BIT would be with the Commission on the basis of the following grounds:
• incompatibility with EU Law (on this see the recent ECJ decision on the problematic capital transfer provisions in Austrian, Swedish and Finnish BITs C-205/06, 249/06 and C-118/07)
• overlap with provisions of a EU negotiated instrument with the third country (such as the FTAs with Chile or Corea);
• incompatibility with the new EU policy on investment that is to be developed and implemented by the Union’s institutions;
• if the Council does not act for a year on the Commission’s request for a mandate for negotiating an EU instrument that would substitute member state BITs.

While the first two grounds are unproblematic (and the second rather redundant because of the first), the third and fourth ground have been subject to criticism and objections. How is an EU policy actually determined so as to serve as a benchmark for allowing legal action against a member state BIT? And why should the Commission be able to punish the member states for not playing ball by sacking their BITs? As suggested in the report – and now picked up by the Rapporteur in the Parliamentary Committee – the former can be addressed rather by providing a narrow interpretative guideline (see below). And as regards the latter, and as highlighted in detail in the LSE report, there are probably good and legitimate reasons for giving the Commission some leverage against the member states to overcome their reluctance to sacrifice their BITs. Otherwise, the Union’s exclusive competence would risk de facto to degenerate to a merely concurrent competence and thus to dead letter. The Commission, who is the guardian of the Treaties and of the Union’s interests (Article 17(1) TEU), is obliged to propose a procedural framework that will guarantee the efficient development of the Union’s policies and safeguard its exclusive competence against erosion.

Following the hearing in the European Parliament’s International Trade Commission (INTA) on 9 November, the INTA Rapporteur, the Swedish Green MEP Carl Schlyter, has presented his draft Report which contains a number of important amendments to the Commission’s draft regulation on the transitional arrangements for the member state BITs, see here (click on PE452.807, then on pdf). This draft report introduces yet another major challenge to the Member States. It proposes to include a “sunset” clause that would limit the Union’s provisional authorisation for the existing BITs of EU member states with third countries (NB: not intra-EU) to a maximum of 13 years (8 years, extendable by another 5 years). Such a sunset provision would mean that all member states would be required to terminate their BITs, which would mean the end of more or less half of the world’s BITs by the end of that period. This suggestion is likely to cause much uproar in the practitioner community and in the member state governments, who will probably try to get this proposal struck down already in the INTA itself.

What may appear as a radical attempt to liquidate the existing BIT generation quicker than proposed by the Commission is, however, not all that irrational in terms of legal certainty. After all, virtually all the BITs in question contain termination clauses that provide for continuing protection for an additional 20 years after the termination. There is no doubt that this extended protection will remain in force under international law irrespective of any withdrawal of authorisation by the EU. This means that the current system of investment protection for investments already made and those made within the next 13 years will continue to be effective at least until the year 2043 (in the most unlikely event that the draft Regulation was adopted this year). This sunset horizon of over 30 year should exceed the projections and the respective need for legal certainty of most (prudent) investors even in large infrastructure or oil & gas projects.

A totally different question is whether, in practical terms, the Commission will be capable not only to review the existing 1,200 BITs in the next (after the suggested amendment now only) four years but, moreover, substitute them by negotiating some 180 new treaties within the next 13 years. This would certainly be quite a herculean effort. But the Rapporteur‘s understanding is apparently that things will only move if there is sufficient pressure to press forward. In any case, the operation of the termination clauses in the BITs would again allow for a much larger time frame. One would not need to worry too much about investors finding them standing in the rain without any umbrella (that is, even ignoring the debate about whether prudent investors actually require such an umbrella in the first place for their adventures).

As regards more detail, the Rapporteur followed the LSE study on the need to have some specifications for defining the EU’s policies the incompatibility with which would allow the Commission to withdraw the authorisation for a BIT. Following the lines of the ECJ’s PFOS decision (C-246/07 ¶¶ 76 et seq.), the Report refers to policies “as specified in individual or general mandates to open or to conclude negotiations with third countries or other acts or concerted practices of the Union’s institutions in the field of the common commercial policy”. Furthermore, the amendment would contain a reference to the general principles of the Treaties, which refer, inter alia, to human rights, equality, sustainable development, free and fair trade and the eradication of poverty. Again, this reference will, no doubt, be coined as a dangerous heavy politicization of investment treaty law and an inacceptable reflection of the Rapporteurs political colours. It has to be born in mind, however, that the European Union’s explicit commitment to these values is found in the Treaties themselves and goes hand in hand with its institutions’ obligation to promote them also in their dealings with third countries (Article 3.5 TEU). This politicization is thus not much more than the inevitable consequence of the transfer of powers to the EU for foreign investments and will be much more accentuated by the necessary involvement of the European Parliament in the definition of the European commercial common policy.

For the rest, the Report’s amendments attempt to streamline the language of the Commission draft and to emphasize the need for the Commission to be able to make the Union’s interest heard before investment arbitrations. Worth noting in this respect is that the report suggests introducing a new ground for the withdrawal of authorisation for a BIT if its dispute resolution provision prove to be an obstacle to the EU Commission’s participation, at least as amicus curiae, in arbitrations brought against a member state. Again, this is an amendment which is likely to cause protest since it will put much pressure on arbitral tribunals to think twice whether they want to deny the Commission amicus curiae status. However, the experience with the Commission’s intervention seems to have been a rather constructive one, so there does not seem to be much need to worry on this front.

What does this development mean for the future of investment arbitration? First of all, we are so far only talking about proposals – which can only come into force if accepted by the majority of member states in the Council. Given many member states’ stern opposition in this matter, the next months will be dominated by their attempts to persuade MEP’s of other colours that the Rapporteur to obtain changes that would shield their BITs against EU interference and extend their life line of their BITs. Their fundamental position is that BITs must remain in force until effectively substituted by EU instruments. This position, however, is difficult to sustain. On one hand, as put radically by one national policy advisor in a discussion at the London School of Economics on 10 November 2010 (see here), the member states are conscious that most (“99%”) of their BITs are to some degree incompatible with EU law. On the other hand, the member states themselves agreed with the Lisbon Treaty that the matter of regulating and thus also protecting foreign direct investments is of the exclusive competence of the Union. This means that the Commission needs to have a reasonable margin of manoeuvre to develop and implement the Union’s policies, let alone the (already existing) power to force member states to bring their legislations and treaties in line with EU law (as shown by the ECJ’s decisions against Austria, Sweden and Finland).

It therefore seems rather likely that the way forward will be tough negotiations on the basis of the text that is presently on the table. As in any difficult negotiation, all sides will have – and can be expected to have anticipated – to make some concessions. In the alternative, i.e. if the Council were to refuse any procedural framework more or less along the lines proposed by the Commission, the latter will be forced to take a much more aggressive approach, which would be the use of the infringement procedure and litigation over the member state’s obligation to cooperate. This will not help the general objective of preserving legal certainty – a goal that all stakeholders claim to be committed to. What is certain is that the Commission will press forward in this matter; that Parliament will demand more participation in the process; and that the member states will have to accept that the days of their BITs are numbered, however generously… Irrespective of what the sunset will eventually look like, we can probably expect the dawn of a new generation of BITs under European lead rather sooner than later.

The decisions of the Second and Ninth Circuit apparently did not trouble the Fifth Circuit, since it merely summarized them without any criticism. In fact, the Second and Ninth Circuit had folded their understanding of “manifest disregard” into the ground of § 10(a)(4) FAA, the “excess of powers” exception (which had already been the pragmatic position of the Ninth Circuit prior to Hall Street), and thus saw no conflict with the Hall Street finding about the exclusivity of the ground for vacatur under the FAA.

The Sixth Circuit’s decision, in contrast, clearly upset the Fifth Circuit, albeit probably not for the decisive reasons. The Sixth Circuit, dwelling on the passage in Hall Street that “[m]aybe the term ‘manifest disregard’ [in Wilko] was meant to name a new ground for review…”, had concluded that “[i]n light of the Supreme Court’s hesitation to reject the ‘manifest disregard’ doctrine in all circumstance, … it would be imprudent to cease employing such a universally recognized principle”; Coffee Beanery, Ltd. v. WW, L.L.C., 2008 U.S. App. LEXIS 23645 (6th Cir. 2008), at **12. This, according to the Fifth Circuit, would be – and probably is – incompatible with the Supreme Court’s holding “that the statutory grounds [for vacatur found in § 10 FAA] are exclusive.”

What the Fifth Circuit, however, ignored is that the Sixth Circuit’s opinion was also – and much more so – flawed in another respect. The Sixth Circuit’s Coffee Beanery decision concerned the application of the Maryland Franchise Act (for the consequences of this decision see another earlier post). The court didn’t actually care that the award had confirmed a franchise agreement which the franchisees had been lured into by material misrepresentations. It cared, however, about the arbitrator’s interpretation of the Act that the franchisor was not required to disclose his representative’s conviction for larceny in the offering prospectus. The Sixth Circuit concluded that because the franchisees were “deprived of a mandatory, statutorily required notice, prior into entering into the franchise agreement, and did not have an opportunity to avoid being subjected to the consequences of having entered into the contract (including the requirement to arbitrate such claims), [the franchisees] should not be bound by the arbitration provisions of the agreement which it was fraudulently induced into signing in violation of the Franchise Act.”

This exemplifies one of the fundamental problems of the “manifest disregard” doctrine as a stand-alone ground for vacatur: courts are tempted to use it as a factotum instead of soundly applying the law. The Sixth Circuit thought it needed to rely on the “manifest disregard” doctrine when it actually did not. The review was not one of the merits but of the arbitrator’s finding concerning her own jurisdiction. The court in fact applied – unconsciously – the Supreme Court’s normal standard of full review of the validity and scope of the arbitration agreement as deriving from First Options v. Kaplan, 514 U.S. 938, 943 (1995). Coffee Beanery simply was not a “manifest disregard” case.

All in all, the Fifth Circuit’s opinion shows that there is probably no reason to expect a post-Hall Street split of the Circuits on the issue of “manifest disregard”. The Fifth Circuit acknowledged, without any objection, the integration of the “manifest disregard” doctrine into the § 10(a)(4) FAA by the Second and Ninth Circuit. Had the Sixth Circuit not insisted imprudently on the possibility of “manifest disregard” being an independent ground of vacatur, but had it dwelled upon the Supreme Court’s passage acknowledging that, “as some courts have thought, ‘manifest disregard’ may have been shorthand for § 10(a)(3) or § 10(a)(4),” the Fifth Court would probably not have had much objections at all. Indeed, it vacated the district court’s judgement which had vacated the award on the ground of manifest disregard of the law, but noted explicitly that “[t]he court, however, did not consider whether the grounds asserted for vacating the award might support vacatur under any of the statutory grounds” and remanded “for further consideration not inconsistent with its opinion.” This could well be understood as an encouragement for the district court to follow the track of redefining “manifest disregard” as a form of “excess of powers”.

No doubt, this solution is unsatisfactory because it puts unnecessary strain on the interpretation of § 10(a)(4) FAA, which being an exception should be interpreted restrictively. It has to be admitted, though, that the courts’ worries underlying their dependency on the “manifest disregard” corrective are frequently legitimate. These worries could certainly be accommodated in a doctrinally much sounder way (unfortunately, there is not the space to elaborate this here). In the meanwhile, giving “manifest disregard” a provisional home under the roof of § 10(a)(4) FAA seems to be a solution that everybody – at least all U.S. courts, which have unanimously embraced the “manifest disregard” doctrine in the past – can live with, at least if restricted to “those exceedingly rare instances where some egregious impropriety on the part of the arbitrators is apparent”, as reaffirmed by the Second Circuit in Stolt-Nielsen SA v. AnimalFeeds Int’l Corp., 548 F.3d 85, 91-92 (2d Cir. 2008).