The Courts Strike Back

The Shell case, decided by the Hague District Court on 26 May 2021, is part of a growing body of climate cases. So far, the successful cases within the EU had been brought against states. In different legal contexts, the Netherlands, Ireland, France, and Germany were required by their national judiciaries to further reduce emissions. The Shell case extends this obligation to a private party, but not any private party. Royal Dutch Shell is one of the 5 biggest multinational oil companies.

I argued before that the Urgenda case in the Netherlands and the Climate Protection Act case in Germany defended rather than undermined separation of powers and furthered rather than threatened the legitimacy in modern constitutional democracies. The Shell case raises the question: Can courts also require private parties to take urgently necessary climate action or does this go one step too far? (For the latter view see here and here)

This is also an issue of separation of powers, because the critics do not question whether emission reduction obligations may be imposed at all (for example in national legislation) but whether it is for the court to do so. I argue here that the Shell case is justified in light of separation of powers.

National judiciaries must be able to act also against private parties in order protect the function of the judiciary in constitutional democracies. What the Shell case does is that it liberates the political-decision maker from the suffocating grip of investor state dispute settlement (ISDS) mechanisms, in particular the mechanism under the Energy Charter Treaty (ECT).

Reliance by energy companies on the ECT has drawn disputes away from constitutionally embedded, independent national judiciaries into the questionable twilight of investment arbitration. Whenever taking climate actions, national governments need to consider the ECT. Compensation paid is paid with the possibility in mind that companies turn to international arbitration. This is also the case in the implementation of climate cases against states. By stepping up and demanding compliance with human rights, also from private parties, national judiciaries could effectively intervene and stop this process of hollowing-out the institutional structures that ensure the democratic will-formation process.

Separation of powers in constitutional democracies

In constitutional democracies the legitimacy of public policy making rests on separation of powers, which are meant to enable democratic will-formation and control the exercise of public power. By allocating different functions to the three branches, executive, legislature, and judiciary, separation of powers aims to ensure that the tension between law and majoritarian politics is perpetuated and that neither law nor politics dominates the other. There is no one blue print of separation of powers. It is different in every EU Member State. Two points are worth highlighting: separation of powers is rightly understood in functional and relational terms. It concerns the institutional interactions between the branches according to their different functions rather than their isolation from each other.

The ideal division of powers gives the legislature the role of adopting general rules on controversial issues. The legislature is considered to be better placed to assess all relevant considerations and balance conflicting interests. Judges have to follow rather rigid procedural and substantive legal rules that necessarily include some aspects as legally relevant and exclude others. Yet, the judiciary has a function in constitutional democracies, also on highly politicized terrain.

Climate change illustrates the perfect storm in this regard. It highlights the limits of majoritarian politics – predominantly for two reasons: First, the worst effects of climate change are still to come and will be worse in other parts of the world. Second, climate change is an international problem and national or even regional action may seem like a drop on a hot stone. The German Constitutional Court discussed some of these limitations of political process in the Climate Protection Act case.

Hollowing Out the Institutional Interaction Within Constitutional Democracies: The Ills of Investor State Dispute Settlement (ISDS)

ISDS mechanisms suffer from fundamental legitimacy problems, including lack of independence of the arbitrators, lack of embeddedness in a broader constitutional system that accounts for other than investment interests, and lack of transparency. There can be little doubt that ISDS tribunals cannot exercise the constitutional function of the judiciary within constitutional democracies, amongst others to check the exercise of public power of the institutions in light of the constitutional legal framework in which all of them are situated and which is co-created by the three branches. ISDS tribunals are also not meant to do so. Investors choose to bring disputes to ISDS mechanisms specifically in order to remove disputes from their constitutional setting.

Hence, ISDS hollows out democratic processes in two ways: first, through regulatory chill; and second, by removing disputes from the judiciary (see also the Achmea ruling by the Court of Justice of the European Union). Socially desirable changes with democratic support may not be made because of the risk of (excessive) claims to compensation. In addition, democratic will-formation must, because of the removal, take place without the input of the judiciary. The will-formation process lacks the input of the national judiciaries exercising its function of protecting individual autonomy, enforcing the right to justification, and checking that public policy-making meets its constitutional obligations, including in terms of human rights.

Investment in Fossil Fuel: Hindering the Democratic Process?

Regulatory chill is a reality. Investments of the fossil fuel industry today are the basis for ISDS claims for compensation payments paid by the taxpayer tomorrow. This directly interferes with the political freedom of governments now and in the future. It adds to the limitations of politics in face of climate change as discussed above.

The Energy Charter Treaty (ECT) has proven to be particularly problematic in this regard. The ECT is the most frequently invoked international investment agreement. Claims related to fossil fuels are the absolute largest share of the (known) damages awarded in claims relying on the ECT. Both arbitration awards and settlement payments for ‘amicable agreement’ constitute a great financial risk for policy makers. Against the Netherlands only, two ECT large arbitration cases are pending/in the process of being filed by RWE and Uniper, respectively. Both claims concern compensation for lost earnings from coal-fired power plants in light of the Dutch choice to phase out coal by 2030.

In 2015, the Maasvlakte Power Station started operating. It was constructed by Engie (formerly GDF Suez). In 2017, the Dutch government explicated its intention to close all coal plants by 2030 in its coalition agreement. The investigations of whether the plant could be transformed to a biomass plant are still ongoing. In 2019, two years after the legislative decision to phase out coal, Engie sold the Maasvlakte Power Station to Riverstone Holdings. Economically, the possibility of compensation and, if need be, an arbitration claim under the ECT are relevant in the economic calculation of such a deal. It significantly reduces the risk of investment if the biomass plan falls through.

In December 2020, Riverstone agreed to take a subsidy from the government to close the plant; however, negotiations are still ongoing regarding the final amount of compensation. If the parties do not reach an agreement, a claim under the ECT could be an option for Riverstone.

How Shell Strengthens the Role of the Judiciary and Reinstates institutional Interaction

In Shell, The District Court held a big multinational corporation responsible under Dutch tort law (Articles 6:162 and 3:296 Dutch Civil Code) for its contribution to climate change. The case relies heavily on the earlier Urgenda case, in particular for establishing that climate change is a human rights matter and that this leads to a duty to protect. In the interpretation of the open-textured norms of the Dutch Civil Code, the District Court of The Hague relied heavily on international norms, including the Paris Agreement. Does holding private parties to respect human rights strengthen or weaken separation of powers?

Climate cases, including the Shell case, bring human rights and international commitments – other than investment law – back into the calculation. Urgenda and the Climate Protection Act case put pressure on the public policy-maker to adopt more far reaching climate measures. Thus far this pressure squeezes the legislature and the executive between their obligations flowing from human rights, explicated in these climate cases, and the possibility of costly awards/settlements under ISDS/the ECT. The Shell case addresses the root of this problem, by imposing an obligation to respect human rights on private parties under private law.

The Shell case changes the calculation of whether further investment in fossil fuel has a business case. It weighs against investing in a line of business of which we know will destroy the planet and is also unlikely to bring market profits in a medium-term future. Royal Dutch Shell is given official legal notice that it has a legal responsibility to act in the face of climate change.

Royal Dutch Shell can also no longer claim that it did not know that fossil fuels are under legal pressure. Hopefully, it could not make claims based on an ignorant ‘right to invest’ under the ECT.

ISDS claims are usually based on the presumption that (arbitrary) government action violated the legitimate expectations of the investor. The Shell ruling, both in its reasoning and use of evidence, undermines the argument that fossil fuel companies can reasonably have any expectation that their investments will not be affected by government action. In other words, the framework of consideration for private parties is redefined by the Shell ruling. The risk has heightened that pay-off by claiming taxpayer compensation in arbitration settings is not possible.

The Shell ruling serves separation of powers because it brings the powers back to the institutions that serve the constitutional function of protecting the rule of law. It offers a forum to non-investors to make their human rights claims heard and, by doing so, works against the structural hollowing out of the institutional interaction by ISDS, which plays a prominent role in the context of climate change. The ruling reaffirms the judiciary’s role in protecting human rights and gives back space to the legislator by lowering the risk of billion-dollar claims driven by narrow financial interests.