THE AUTHORS:
Georg Scherpf, Head of Arbitration Germany at Clyde & Co
Lale Defne METE, Managing Partner at CBC Law
Gürhan Aydın, Partner at CBC Law
Benedikt Kaneko, Law Clerk at the Higher Regional Court of Hamburg
This blog post looks at Investor State Dispute Settlement (“ISDS”) from Turkish and German perspectives by outlining the existing investment protection in place (I.), possible investment structuring (II.), stabilization agreements and arbitration clauses in state contracts (III.), remaining pitfalls (IV.), the enforcement of investment arbitration awards (V.) and the future of ISDS from a Turkish-German perspective (VI.).
Investment Protection
Foreign investments are protected in both Türkiye and Germany by domestic laws and international investment agreements. International investment standards contained in international agreements are often enforced through an ISDS mechanism – most often arbitration. This allows foreign investors to choose investor-state arbitration as a dispute settlement mechanism over domestic legal recourse and directly against the host state in the absence of a contractual relationship. Türkiye has signed Bilateral Investment Treaties with 108 countries, and 85 of them are currently in force. The relevant international investment agreements in place between Türkiye and Germany are the Energy Charter Treaty (1994) (“ECT”) and the Germany – Türkiye Bilateral Investment Treaty (“Germany – Türkiye BIT”).
The Germany – Türkiye BIT was concluded in 1962 and entered into force in 1965. It is one of the earliest BITs that were concluded. It contains a broad definition of investor and investment to include natural persons and legal entities with any kind of asset as an investment. Substantive protections include the commonly found investment protection provisions: fair and equitable treatment (“FET”) of all investments and protection against direct and indirect expropriations. The FET standard is basically understood to safeguard against unreasonable, arbitrary, and discriminatory treatment; failure to offer a stable and predictable legal framework; lack of transparency and denial of due process and justice; and frustration of an investor’s legitimate expectations.
However, the Germany-Türkiye BIT does not include any provision for an ISDS mechanism. Investors cannot bring an investor-state arbitration under the BIT in case of a treaty violation by the host state. Investors will have to fall back to domestic courts for any potential enforcement and compensation in case of a violation of the BIT. Hence they are not offered the possibility to settle their dispute in a neutral forum.
Türkiye and Germany are both contracting parties to the ECT, which provides investment protection for investments in the energy sector. While it provides for an ISDS mechanism through arbitration, the limited scope of protected investments naturally limits its usefulness for investments in other sectors. For investments in the energy sector, the ECT provides substantive investment protection similar or better to most BITs, i.e., requiring FET and prohibiting unlawful expropriation. The ECT has drawn particular attention considering state regulations on energy transition from fossil fuels to renewable energy.
Against this backdrop, the contracting parties to the ECT have, in principle, agreed on the modernization of the ECT regime in June 2022. Germany, as well as several other EU Member States, have withdrawn from the ECT at the end of 2022, as they do not consider the reform process sufficient. In Art. 47, the ECT contains a sunset clause that guarantees continued investment protection for existing investments for the next twenty years. At least for this period, the ECT will continue to provide the gold standard for investment protection for investors between Türkiye and Germany in the energy sector.
Investment Structuring
Since there is no bilateral agreement between Türkiye and Germany that would include both broad investment protection provisions and robust ISDS mechanism, Turkish and German investors may consider structuring their investment in the respective other country through subsidiaries and entities in third countries. Investors can benefit from the regulatory framework, i.e., the investment protection, including ISDS, between the third country and Türkiye/Germany.
For example, the BITs Türkiye has concluded with some of Germany’s neighbours like Austria, the Netherlands, and Belgium-Luxembourg all include investment protection chapters with strong ISDS mechanisms, which investors have used in the past to bring investment arbitrations against Türkiye. The BIT in force between the Netherlands and Türkiye, for example, includes a FET clause and protection against direct and indirect expropriations while providing for an investment arbitration as a dispute settlement mechanism. Considering structuring an investment does not have to be a difficult exercise, but one more factor for a prudent investor to consider.
Direct (re-)structuring can route the investment through a legal entity within the investor’s corporate structure, which is incorporated in the third country, and transfer control over the investment to this entity. Having the investment itself channelled through a special purpose vehicle owned by an entity incorporated in the third country, provides for a more indirect, yet equally effective, form of (re-)structuring.
Some also refer to this practice as treaty shopping, but it is generally considered legitimate if the timing and purpose of restructuring are not considered to be an abuse of process (see Mobil and others v. Venezuela, Decision on Jurisdiction, 10 June 2010, para. 204). Arbitral tribunals have denied treaty protection for investors’ restructuring efforts for the sole purpose of accessing treaty protection without a legitimate economic or business purpose or only after a dispute is “already on the horizon” (see Philip Morris v. Australia, Award on Jurisdiction and Admissibility, 17 December 2015, para. 554).
Ultimately, whether the investor can avail himself of the desired treaty protection will depend on the individual case and the treaty in question. Interested investors should proactively – without a dispute “on the horizon” – evaluate their structure for existing and future investments to ensure the application of the most favourable regulatory framework from an investment protection perspective.
Stabilisation Agreements and Arbitration Clauses in State Contracts
Investment protection and related investor-state arbitrations can also be based on contracts between investors and states or state entities. In this context, stabilisation agreements and arbitration clauses have drawn particular attention.
A stabilisation agreement or stabilisation clause can be included in a contract between the investor and the host government – or any other international investment agreement, for that matter – and addresses how regulatory changes by the host state that follow the execution of the stabilisation agreement are to be treated. In other words, whether and to what extent changes in the regulatory framework by the host state will affect the foreign investors’ rights and obligations and trigger compensation.
Stabilisation agreements are generally beneficial to foreign investors, as they often provide for a freezing of the regulatory framework that cannot be changed to the detriment of the investor for the duration of the contract – which could be several decades – without triggering a state’s responsibility to pay damages in case of unfavourable changes. This provides predictability and stable conditions for the investor and its investment. Stabilization agreements are often coupled with a dispute resolution clause (arbitration) to ensure their enforcement. On the other hand, freezing the regulatory framework is said to prevent host governments from taking actions that are deemed necessary in view of compensation claims – the so-called regulatory chill. However, there is little to no empirical evidence to proof that effect.
There have been debates on whether stabilisation clauses are always binding to the host state and enforceable by the investor in an investor-state dispute. Arbitral tribunals have often enforced stabilisation agreements. However, the governing law of the contract that includes the stabilisation agreement regularly plays a significant role in enforcement. Turkish and German law does not generally prohibit stabilisation agreements.
Under both German and Turkish law, however, general contract law provides a variety of possibilities for the state to attempt to argue that the clause in question is, e.g., abusive, excessively long, or otherwise overly burdensome in a given special circumstance. Whether such a claim will be successful is doubtful but should always be considered considering the specific agreement and the existing circumstances. For example, the Baku Tbilisi Ceyhan Pipeline Project provides for a stabilization clause, according to which Türkiye undertakes not to make any legal amendment for a period of 40 years that would adversely affect the project.
Arbitration Clauses with State Entities
There are no limitations, albeit some points to bear in mind, when concluding arbitration clauses in contracts with the German government or state entities. The same applies to Türkiye, where the government and Turkish state entities can include arbitration clauses in their contracts as permitted by the Foreign Direct Investment Law (“FDIL”). In other jurisdictions, the enforceability of arbitral agreements with state entities might depend on governmental internal approval procedures that might not be transparent for the investor at the time of the conclusion of the arbitration agreement. We have not been able to identify any such obstacles for arbitration agreements relating to German or Turkish state entities.
Pitfalls
Even with investment structuring, some pitfalls might remain. Given the high number of Turkish-German dual-nationals, this section addresses the challenges they face under most investment treaties.
Investment protection is regularly afforded by host states to foreign investors. Whether an investor is foreign is determined by its nationality. Dual nationals, i.e., those with the nationality also of the host state, risk being considered non-foreign for investment protection, and arbitral tribunals in the past have refused to exercise jurisdiction over claims brought by dual nationals.
Some investment treaties do not exclude dual nationals per se, but only those whose dominant and effective nationality is that of the host state. Arbitral tribunals in the past have looked at a variety of points to determine the dominant and effective nationality. These include, e.g.:
- the habitual residence;
- how the second nationality was acquired;
- the personal attachment to a particular country; and
- the centre of the economic, social, and family life. Whether or not a dual national can bring a claim against the not-so-foreign host state will depend on the applicable framework and the living realities of the dual national.
For legal entities, nationality is regularly determined by the place of their incorporation or the business seat.
Even if the investor can avail himself of the substantive investment protections awarded to foreign investors, one important procedural ISDS mechanism will mostly not be available to enforce any claim against the host state. The Convention on the Settlement of Investment Disputes between States and Nationals of Other States (1965) (“ICSID Convention”) stipulates in Article 25 that it is not applicable for claims brought by an investor having the same nationality as the respondent state.
Dual nationals will still have access to other arbitration rules like UNCITRAL Arbitration Rules. The ICSID Convention has been particularly popular as it is specialized for investor-state arbitrations but will not be available to dual nationals. This also has consequences for the potential enforcement of an arbitral award because – as we explain below – the enforcement for arbitral awards under the ICSID Convention is following a different and more limited process. The FDIL defines foreign investor as (i) real persons who possess foreign nationality and Turkish nationals residing abroad, and (ii) foreign legal entities established under the laws of foreign countries, and international institutions, who make foreign direct investment in Türkiye. Therefore, in the event of investment by a Turkish national residing abroad, the investment agreement with Türkiye as the host state can include arbitration agreement in accordance with Art. 3 (e) of the FDIL.
In addition to the exceptional approach and practice for dual national actors of an investment dispute, Türkiye has officially made a reservation depending on the subject matter of disputes, especially on claims related to rights in rem over immovable properties. In this respect, Türkiye, as one of the parties to the ICSID Convention, notified that “the disputes related to the property and real rights upon the real estates are totally under the jurisdiction of the Turkish courts and therefore shall not be submitted to jurisdiction of the Centre”. Consequently, investment disputes related to rights in rem over immovable properties in Türkiye needs to be resolved by national courts due to the exclusive jurisdiction of Turkish courts.
Enforcement of Investment and Commercial Arbitration Awards
The enforcement of investor-state arbitration awards is possible in Türkiye and Germany under either the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958) (“New York Convention”) or the ICSID Convention, as both countries have signed and ratified these instruments.
The ICSID Convention provides a framework for enforcing arbitral awards rendered under the framework of the ICSID Convention; the convention itself governs the award’s enforceability under Articles 53-55 of the ICSID Convention. Under Article 54 (1) ICSID Convention, pecuniary obligations contained in an arbitral award can be recognized and enforced in the courts of any ICSID Convention Member State as though it were a final judgement of that state’s court. This, in theory, provides a self-contained system that leaves a very limited role for state courts with little room to resist enforcement. In practice, domestic courts, during the enforcement procedures, will likely hear arguments on limited substantive or procedural reasons to decline enforcement or grant execution of the arbitral award. There are exceptions in the Intra-EU context.
Enforcement of all other investor-state arbitral awards is possible under the New York Convention, which generally governs the enforcement of arbitral awards in its signatory states. Under the New York Convention, the enforcement of an award is only to be denied in a very limited enumerated set of circumstances listed in Article V New York Convention. While the potential review of an arbitral award is limited to mostly procedural matters, Article V(2)(b) of the New York Convention allows for a review of whether the recognition of enforcement of the award would be contrary to the public policy of that country.
While still providing domestic courts with only limited review possibilities, the enforcement under the New York Convention allows for a broader review than the ICSID Convention. Overall, courts in Türkiye and Germany are arbitration-friendly, and arbitral awards are regularly enforced.
Future of ISDS
Germany was a pioneer of bilateral investment treaties in the late 50s, with the first BIT concluded between Germany and Pakistan. Türkiye has equally been one of the first states to embrace the BIT system for investment protection by concluding its first BIT with Germany in 1962 (Germany-Turkey BIT).
To date, Germany has a large number of BITs in force and with ISDS mechanisms in place. Even though it has not changed its favourable view of investment protection and ISDS mechanisms, it, however, is in line with the EU policy to reform the existing investor-state arbitration system in favour of a permanent multilateral investment court. This is reflected in the EU’s latest multilateral trade agreements with Canada and Vietnam that include reference to such an investment court. Due to the inability to agree on an ISDS mechanism and substantive investment protection, the EU-Japan Free Trade Agreement, for example, does not include a chapter on investment protection. One might expect that Germany and the EU will continue to push for a multilateral investment court for any future provisions on investment protection.
Türkiye, on the contrary, does not include any reference to a standing investment court and maintains the classic approach to ISDS in its newer investment protection agreements. However, in the last ten years or so, Türkiye has concluded a significant number of BITs, including substantive investment protection provisions of the so-called newer generation that are not yet in force. This newer generation of provisions defines the concept of investments narrower, excludes umbrella clauses, and limits the treaty’s scope by introducing more exceptions for state regulations that are environment-protection or human rights related.
Since signing its first BIT in 1962, Türkiye has signed over 100 BITs and thereby created an impressive framework of investment protection for Turkish investors abroad and foreign investors in Türkiye. There are no signs that Türkiye plans to change its supportive and inclusive approach to existing investment-arbitration practice as ISDS mechanism.
Conclusion
Investment protection between Türkiye and Germany has a long history, given that the bilateral investment treaty between the two countries is one of the oldest existing and thriving trade between both countries. However, lacking an ISDS mechanism to enforce potential breaches of the treaty, prudent investors should consider possibilities to structure their investments to fall under investment protection provisions that provide for a robust ISDS mechanism like arbitration – especially considering recent political developments.
ABOUT THE AUTHORS:
Georg Scherpf is Head of Arbitration Germany at Clyde & Co. He advises both private and State parties on complex arbitrations and cross-border litigations. His commercial arbitration work covers a broad range of legal issues and sectors including international trade (CISG), corporate disputes (joint venture and post M&A) and energy (particularly offshore wind and construction disputes). His public international law experience includes advising clients in relation to bilateral investment treaties (BITs) and multilateral investment treaties including the Energy Charter Treaty (ECT). He has acted for investors in several complex treaty cases (ICSID, UNCITRAL and ad hoc) relating to infrastructure and energy investments in Spain, Czech Republic, Albania, and Germany.
Lale Defne Mete is Managing Partner at CBC Law. A highly skilled attorney who excels in corporate, litigation, and dispute resolution with a notable career, she adeptly advises a diverse range of clients, including international institutions, national governments, Turkish and international companies, and startups. Her expertise spans asset acquisitions, business transactions, and the resolution of cross-border disputes involving administrative, tax, customs, employment, business crime, and commercial issues. As an active member of professional organizations, Defne’s unique strengths lie in her deep legal understanding gained from in-house counsel roles and NGO representation.
Gürhan Aydın is a Partner at CBC Law and a seasoned attorney with 15 years of expertise in dispute resolution, specializing in corporate and commercial litigation, arbitration, and various legal domains. His proficiency extends to mergers, acquisitions, joint ventures, energy and infrastructure projects, and general corporate matters. With a comprehensive background, Gürhan advises and represents local and foreign entities and individuals in various sectors. His unique perspective from dispute practice enriches his role in drafting agreements, advising on corporate resolutions, and navigating legal complexities.
Dr. Benedikt Yuji Kaneko currently works as a law clerk at the Higher Regional Court of Hamburg as part of the mandatory two-year clerkship for admission to the German bar (Referendariat). He is admitted to the New York Bar (Attorney at Law) and has experience acting in commercial and investment arbitrations under various rules (ICC, SIAC, KCAB, UNCITRAL, and ICSID).
