Description and consequences of Chapter 11 of NAFTA

1. Description and consequences of Chapter 11 of NAFTA November 15, 2007

2. Topics in this lecture • Lack of transparency of process • Articles of Chapter 11. • Performance requirements. • The doctrine of “regulatory taking” and its relation to Chapter 11. • Some Chapter 11 cases.

3. Lack of transparency • There is no requirement of public notification of complaints, and tribunal hearings (typically) are not open to public. • Prior to NAFTA Chapter 11, most BIT cases involved narrow commercial interests, where secrecy protected these interests without public harm. • Some NAFTA cases involve environmental regulation, with clear public consequences. Until recently, public interest groups could not participate. Tribunal ruling in Methanex case accepted “friends of the court” briefs, providing greater public access.

4. Provisions of Chapter 11: National Treatment • Article 1102: National treatment provision requires governments to treat foreign investors of NAFTA countries no less favorably than domestic investors in like circumstances, with respect to all phases and aspects of investment, including initial investment and sale of investment.

5. Discussion of National Treatment • The difficulty of determining "like circumstances" is similar to the problems associated with determining "like products". • Examples: Suppose that a foreign investor builds a new factory. Is it legal to require that this factory meet stricter environmental standards than existing factories? If new factory is located in environmentally sensitive area is legal to regulate it more strictly? If investor owns no other assets in country can it be obliged to post a bond to insure environmental compliance (e.g. cleanup)?

6. Provisions of Chapter 11: Most Favored Nation (MFN) • Article 1103: Most Favored Nation requires governments to treat foreign investors from NAFTA country no less favorably than the best treatment given to investors from other (signatory or non-signatory) nations -- even if this is better than treatment given to national investors. • This article creates the possibility that the provisions of other (possibly bilateral) agreements could be imported into Chapter 11.

7. Provisions of Chapter 11: minimum international standards • Article 1105: Minimum international standards of treatment requires investors be treated "in accordance with international law" and to receive "fair and equitable treatment". • This provision was intended to protect against egregious violations. The claim that domestic firms were being treated equally badly could not be used as a justification of unreasonable treatment of foreign firms -- thus the need for minimum international standards.

8. Minimum international standards, continued • In Metalclad the Tribunal found that Mexico failed to maintain a transparent and predictable investment climate. In July 2001 the Free Trade Commission (the council of three trade ministers) issued an "interpretative statement", to the effect that the requirement to provide treatment in accordance to international law means "customary international law", as distinct from the strictest law (i.e. as distinct from the highest standards).

9. Minimum international standards, continued • FTC cannot “amend” Chapter 11, only “interpret” it. • To what extent is a nation responsible for government acts at a local level? Is a nation responsible for the assurances made by a bureaucrat, regarding the interpretation of a law? Can a Federal official usurp the powers of local officials, by offering an investor assurances?

10. Provisions of Chapter 11, Performance requirements • Article 1106: Forbids use of performance requirements, such as domestic content rules or domestic employment requirements, or export requirements. Parties are also forbidden to use performance requirements for domestic investors, but domestic investors can not use the investor-state process

11. Discussion of prohibition of performance requirements • The rationale for these prohibitions is that performance requirements reduce economic efficiency, because they interfere with the market outcome. • There is a broad issue whether these prohibitions are justified. If investment decisions are the result of a bargain (e.g. between a government and a multinational) then the prohibition of performance requirements reduces the bargaining power of governments.

12. Performance requirements, continued • Some have argued that an import ban is an implicit requirement to use a locally produced input. For example, Ethyl vs. Canada was arguably a dispute about trade, rather than investment. • The issue should be whether the input ban violates some other “discipline” (i.e., trade rule); if so, it is an issue for state to state dispute. • If the import ban is viewed as an implicit performance requirement, this opens the door to investor to state dispute).

13. Provisions of Chapter 11 Expropriation • Article 1110. Foreign investors entitled to compensation from treasuries for expropriations, or any action that is "tantamount" to an expropriation. • Article 1110 prohibits direct or indirect expropriation unless expropriation is: (i) for a public purpose; (ii) on a non-discriminatory basis; (iii) in accordance with due process of law and Article 1105; (iv) on payment of compensation.

14. Regulatory Takings • Fifth Amendment to US Constitution states that private property shall not be taken for public purpose without just compensation. • The state has the right of eminent domain. If the state wants to take your land (e.g. to build a road) it can do so, but must compensate you. • If the state restricts your use of land (e.g. to protect an endangered species) it does not have to compensate you (under US law, decided by Supreme Court), even though this action diminishes the value of your land.

15. Regulatory takings, continued • Does any law or regulation that diminishes the value of an asset constitute an action “tantamount to expropriation"? • Traditional exercise of "police powers" permits countries to act in the public interest without this action being considered a regulatory taking. • Oregon law, last year’s California referendum promote the “doctrine of regulatory takings” (the view that any state action that reduces value of an asset requires compensation). • The Coase Theorem, again.

16. Chapter 11 and regulatory takings • Is Chapter 11 an “end run” around US Supreme Court rejection of doctrine of regulatory takings. It is uncertain how Chapter 11 tribunals will interpret "police powers“. • Tribunal in Metalclad case decided that the motivation of government action was not relevant, so it did not need to decide whether the (local) government action was consistent with the non-confiscatory exercise of police powers. • Tribunal in Methanex case did consider the motivation for state law.

17. The Green article • Article 1114 (the "Green article") "Nothing in this Chapter shall be construed to prevent a party from adopting, maintaining or enforcing any measure otherwise consistent with this Chapter that it considers appropriate to ensure that investment...is undertaken in a manner sensitive to environmental concerns." (e.g. A government can require environmental impact reports, pollution abatement equipment).

18. The environmental effect of Chapter 11 • The decisions that Tribunals take, and the subsequent appeal court decisions, will determine the effect that the agreement has on environmental (and other) public policy. • One tribunal’s decision does not constrain subsequent tribunals. Precedent does not have the same authority in international law that it does in domestic law. • Some of the decisions can be construed as harmful to environmental interests, and others as respectful of those interests. • I will discuss two environmental cases, both involving US firms’ complaints against Canada. In both cases there is reasonable doubt whether the government regulation was motivated by environmental or commercial considerations (i.e. disguised protectionism). Both cases appear to extend the definition of what is meant by “investment”, and blur the line between investment and trade law.

19. Ethyl Vs Canada • Canada banned import of MMT. US firm “Ethyl” sued under Chapter 11, claiming that that the ban “expropriated” Ethyl’s investment in access to Canadian market. The import ban looks like a standard trade restriction. The most interesting aspect of the case is that it potentially makes it easier for trade disputes to be moved to the investment arena. Recall difference between state-to-state and investor-to-state disputes. • The merits of the ban were questionable: Was it a genuine environmental policy or disguised protectionism? • Evidence of genuine environmental motivation for ban: At the time of the dispute, MMT was banned in California and also by EPA regulation, due to public health concerns. • However, at this time the EPA was being required by court order to lift its restrictions and to allow the production and use of MMT in US. The evidence of health effects was inconclusive, so under the terms of Clean Air Act EPA could not regulate its use.

20. Ethyl vs. Canada continued • The claim that MMT interfered with catalytic converters (leading to an additional environmental problem) was dropped. • Canadian environment minister concluded that scientific evidence was insufficient to ban MMT use under Canadian law. • As an alternative to the ban, Canadian government banned import and inter-province trade of MMT. While the NAFTA claim was pending, Province of Alberta initiated a domestic challenge under Canada's Agreement on Internal Trade. The domestic panel ruled in Alberta's favor. • Canadian government removed trade ban and settled with Ethyl, so the case was never heard by NAFTA tribunal. • Environmentalists worry that threat of Chapter 11 litigation would reduce governments’ incentive to pass environmental protection. They see Canada’s retraction of the ban, and subsequent compensation to Ethyl as evidence of the chilling effect, on environmental regulation, of Chapter 11.

21. SD Meyers vs Canada • Meyers’ was in business of remediation of PCB contaminant. Eastern Canada had a large inventory of PCB contaminated equipment but no local disposal capacity, presenting an investment opportunity for Meyer. • Existing bilateral agreement between US and Canada allowed for cross-border movement of hazardous waste, for environmentally sound disposal. EPA regulations under Toxic Substances Control Act banned importation of PCB into US. In 1993 SD Meyers incorporated a company Meyers Canada and began lobbying US and Canadian environmental authorities to relax ban on imports of PCBs into the US. • Meyers received support from Canadian firms, who wanted a cheaper way to get rid of PCBs. (The nearest Canadian disposal firm, Chem-Securit, was in Alberta). • In 1995 the Canadian minister for the Environment announced that "handling of PCBs should be done in Canada by Canadians" thus providing evidence of protectionist intent. • Later that year EPA gave Meyers permission to import PCBs from Canada from Nov 15 1995 through December 31 1997, stating that the environmental risk was negligible, and the SD Meyers would dispose of product in a responsible manner.

22. Meyers continued • The Canadian firm, Chem Security wrote to Canadian Env minister asking for an export restriction. On November 16 1995 the Canadian minister signed an interim order closing the border to PCB exports. • The Canadian minister based his decision on the 1999 "Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and their Disposal". This convention requires that governments "ensure the availability of adequate waste disposal facilities...to the extent possible" within their borders. It also requires that governments minimize the transboundary movement of hazardous waste to a level "consistent with the environmentally sound and efficient management of such wastes". (The US is not a signatory of this Convention.) • However, the Canadian government has previously allowed PCB exports to the US, on the advice that this movement was consistent with Basel Convention and the US-Canadian treaty on transboundary movements of hazardous waste, and in the belief that the environmental risk of transboundary shipments was smaller than the risk of longer intra-national shipments. • Canada had also expressed the view that the Basel Convention should not be construed to prohibit environmentally sound transboundary shipments of waste. The government confirmed the minister's order on Feb 26 1996.

23. Meyers continued • One view is that the ban was motivated by environmental considerations and consistent with the Basel treaty obligation. Another view is that the motivation for the ban was commercial – the support of Canadian firms. Possible reconciliation of these views: in absence of ban the Canadian firm might not have enough volume to remain in business, and their absence would be bad for the environment. • The Canadian government reversed its ban in February 1997, allowing Canadian PCB exports into the US under certain conditions. SD Meyers imported 7 shipments into the US, until the border was closed by the action of a US Judge, following a Sierra Club challenge to EPA rules. • In October 1998 Meyer's sued Canada for 20 million dollars, their loss resulting from the one year closure of the border. They claimed that Canadian action in closing the border was "tantamount to expropriation" under acticle 10 of Chapter 11 NAFTA. • The tribunal dismissed Meyer's claims of expropriation and violation of prohibitions against performance requirements, but it found violation of the national treatment provision. The tribunal found that the Canadian objective of maintaining domestic capacity could be achieved by other, less distorting methods, e.g. government contracts and subsidies. (The Principle of Targeting!) • Tribunal found that Meyer's claim to a share of Canadian PCB market constituted a legitimate investment. If “market share” can be viewed as an asset (like a factory) that is protected under investment agreements, the line between trade and investment becomes very blurry

24. Summary: Arguments in favor of ITs • Ostensible purpose of ITs is to promote an investment-friendly environment, by protection sunk costs. • IT also provides a way to lock in future liberal policies. The anticipation of liberal investment climate in future may promote current investment (e.g. by making it more likely that “complementary” investments will occur in the future. • The empirical evidence of actual effect of ITs on FDI is unclear.

25. Summary: Main objections to ITs • “Ex post” rules (e.g. those on expropriation) reduce a host’s ability and willingness to protect environment. • “Ex ante” rules (e.g. those on performance requirements) reduce a host’s bargaining power vis-a-vis investor. • Trade disputes might be construed as investment disputes, enlarging the scope of investor-to-state litigation. • The process is secretive and undemocratic.