No fruit from the poisonous tree – The Bavarian Highest Regional Court declines recognition of a cost award rendered in an intra-EU investor-state arbitration

In a recent decision (order of 13 September 2024 – 11 Sch 146/23), the Bavarian Highest Regional Court (BayOblG) ruled on the recognition of an arbitral award on costs that had been rendered in an arbitration conducted pursuant to the UNCITRAL Arbitration Rules and administered by the Permanent Court of Arbitration in The Hague. The proceedings had been initiated by German investors against the Czech Republic under the Energy Charter Treaty and the bilateral investment treaty between the Czech and Slovak Federal Republic and Germany. The arbitral tribunal had assumed jurisdiction but dismissed the claimants’ claims on the merits and ordered them to compensate the respondent for a large part of its costs. The BayOblG refused to declare the arbitral award enforceable, holding that the underlying arbitration agreement was incompatible with EU law and therefore invalid. The decision touches upon procedural issues that extend beyond international investment law.

Arbitral tribunal assumed jurisdiction and issued cost award based on merits

The BayOblG ruling of 13 September 2024 concerns an investor-state arbitration between two German investors and the Czech Republic regarding national energy regulation. The arbitration had been initiated by the investors in May 2013 based on the Energy Charter Treaty (ECT) and the bilateral investment treaty between the Czech and Slovak Federative Republic and Federal Republic of Germany (1990) (CZ-GER BIT). In January 2014, the parties agreed in so-called Terms of Appointment on the composition of the arbitral tribunal, the application of the UNCITRAL Arbitration Rules and the administration of the proceedings by the Permanent Court of Arbitration in The Hague. In a procedural order issued in March 2014, the arbitral tribunal moved the seat from The Hague to Geneva. The European Commission sought to be admitted as “Non-Disputing Party” with a view to presenting to the arbitral tribunal its position on the inadmissibility of intra-EU investor-state arbitrations. In March 2015, the arbitral tribunal rejected this application. In the further course of the proceedings, the Czech Republic expressly waived its right to rely on the jurisdictional objection articulated by the European Commission. On that basis, the arbitral tribunal, in March 2018, refused to grant the Czech Republic leave to submit the judgment of the European Court of Justice (ECJ) in the Achmea case to the file. In Achmea, the ECJ had declared investor-state arbitration agreements in bilateral investment treaties concluded between EU member states to be incompatible with EU law. On 2 May 2018, the arbitral tribunal rendered the final award, in which it accepted jurisdiction but dismissed the case on the merits. Taking into account that the claimants had prevailed on one major disputed point but failed on the merits, the arbitral tribunal ordered the claimants to compensate the respondent for its legal costs in part.

BayObLG ruled lack of valid arbitration agreement affected the tribunal's cost decision

Before the BayOblG, the Czech Republic applied for a declaration of enforceability of the arbitral award.

Referring to Article V(1)(a) of the New York Convention, the BayOblG dismissed the application for declaration of enforceability for lack of a valid arbitration agreement. The Court held that, under EU law, the Czech Republic could not submit a valid offer for the conclusion of an arbitration agreement. Summarising the ECJ's judgments in Achmea and Komstroy, the Court concluded that the dispute resolution mechanisms in Article 26(2)(c) and (3)(a) ETC and Article 10(2) CZ-GER BIT were incompatible with EU law, irrespective of whether non-EU jurisdictions regarded the arbitration agreements as valid. The BayOblG also took the view that the Terms of Appointment did not contain a separate arbitration agreement since it was limited to procedural and administrative matters. Referring to the ECJ's decision in PL Holdings, the court added that such an arbitration agreement would be invalid anyway. The court concluded that the arbitral tribunal had erroneously assumed jurisdiction.

Turning to the question whether the tribunal's cost decision can be separated from the decisions on the merits, the BayObLG emphasised that each item of the dispositive part of the arbitral award must be assessed individually regarding recognition and enforceability of the decision. The court held that in the given circumstances, however, the lack of a valid arbitration agreement also infected the tribunal's cost decision because the arbitral tribunal allocated the cost of the arbitration based on its decision on the merits. In the court’s view, the cost decision was intertwined with the tribunal's assumption of jurisdiction. As a result, the court held that it could not be recognised pursuant to Article V(1)(a) NYC.

The BayOblG did not address the closely related question whether an arbitral tribunal that declines jurisdiction possesses the inherent power to rule on costs. The court saw no need to address this question since, in its view, the tribunal had erroneously assumed jurisdiction on the merits. The court also considered it irrelevant whether the arbitral tribunal would have reached the same cost decision if it had declined its jurisdiction.

Finally, the BayOblG held that the investors were not precluded from relying on the invalidity of the arbitration agreement in the enforcement proceedings since the Czech Republic had not raised the jurisdictional objection in the arbitration proceedings.

Implications of the ruling

The BayObLG's ruling applies the settled case-law of the ECJ on the incompatibility of intra-EU investor-state arbitrations with EU law to the cost decision of intra-EU arbitral awards. The decision has practical implications for intra-EU awards but also for cost awards in general:

• The fact that the tribunal and the parties agreed on terms of appointment or terms of reference at the outset of the proceedings cannot per se be read as providing for a separate arbitration agreement where the underlying arbitration agreement is null and void.
• The invalidity of an arbitration agreement renders a cost decision unenforceable where the tribunal erroneously assumed jurisdiction and the cost decision reflects the tribunal’s determinations on the merits.
• Whether a tribunal declining its jurisdiction in intra-EU investor-state arbitrations has the (inherent) power to render a cost decision is an open question that has not yet been finally answered by the German courts.

The decision of the BayOblG can be accessed in the German language here.