From NAFTA to USMCA: How could the Elimination of the ISDS Mechanism Impact Canada?

Exclusive Summary

On 19 June 2019, Mexico became the first country to pass the United States-Mexico-Canada Agreement (USMCA) as a replacement to the existing North American Free Trade Agreement (NAFTA). While most of the attention has been devoted to changes to labor provisions and trade barriers in the dairy market, an overlooked aspect has been the elimination of the Investor-State Dispute Settlement (ISDS) mechanism between the US and Canada, and Mexico and Canada. This article will elaborate on how the elimination of ISDS could impact Canada’s policy making and the inflow of Foreign Direct Investment (FDI), from other countries of NAFTA to Canada.

 

General Overview of Chapter 11 of NAFTA and the Recent Changes in the USMCA

Under Chapter 11 of NAFTA, investment disputes between investors and states are to be settled in front of an international arbitral tribunal through the ISDS mechanism, which allows foreign investors to sue the host nations of their investment for alleged discriminatory practices. Now, under Chapter 14 of the USMCA, Article 14.2(4), “an investor may only submit a claim to arbitration under this Chapter as provided under Annex 14-C (Legacy Investment Claims and Pending Claims), Annex 14-D (Mexico-United States Investment Disputes), or Annex 14-E (Mexico-United States Investment Disputes Related to Covered Government Contracts)”. In other words, an investor can no longer submit a claim to arbitration against Canada. Instead, the investor will have to bring his/her claim before Canadian national courts.

The only exception to this new provision that excludes Canada from arbitration is contained within the Annex 14-C which concerns “legacy investment claims and pending claims”. According to Annex 14-C, Canada’s consent to ISDS for legacy investment claims is still valid until three years after the date of termination of NAFTA (which has not been set as of today) [1].

 

History of Dispute Settlements Between Foreign Investors and the Canadian Government under NAFTA Chapter 11

Canada has been a frequent target of lawsuits brought by foreign investors before NAFTA’s ISDS tribunals. According to a report done by the Canadian Centre for Policy Alternative, roughly 48% of the 85 known NAFTA claims (as of January the 1st2018) have been filed by foreign investors against the Canadian government [2]. The Canadian government has been targeted in 43 ISDS cases compared to Mexico (23) and the USA (21) [3]. Canada has not only received the most investor-state claims but has also lost the most cases to foreign investors. Out of the concluded cases which resulted in either an award by the tribunal or in a negotiated settlement, Canada has won 9 cases and lost 8. Canada’s record with concluded ISDS lawsuits stands in contrast with the USA which has won 11 cases and lost 0, and with Mexico which has won 7 and lost 5 concluded cases [4]. These investor-state disputes have cost the Canadian government nearly $314 million which includes $219 million toward settlements to investors and 95$ million for legal defense costs [5]. These are only the direct costs and do not include additional costs of non-legal government staff who vet government regulations/claims or interest payments.

It is not completely clear why Canada has a worse track record than other NAFTA countries when it comes to investor-state disputes. A possible explanation could be that Canada has more economic regulations than other NAFTA countries which makes the government prone to lawsuits from foreign investors. This is especially true for environmental regulations as energy and environmental policies are challenged the most by foreign investors in ISDS. In fact, they make up roughly 77% of ISDS cases involving the Canadian Government.

 

Impact on Canada’s Domestic Sovereignty

Eliminating the ISDS mechanism could enhance the possibility for Canada to implement their policies. Much of the frustration with the ISDS mechanism stems from the belief that Chapter 11 has become a way for foreign companies and investors to successfully challenge government policies that are unfavorable to their business. Although NAFTA investor-state disputes cannot reverse government policies, it may award monetary damages for the investor under Chapter 11, article 1135 of NAFTA. For example, in 1997, the US chemical company Ethylused the ISDS mechanism to challenge a Canadian ban on the import of methylcyclopentadienyl manganese tricarbonyl (MMT). Amongst other concerns, the Canadian Parliament was worried about public health risks. Despite these concerns, under the UNCITRAL arbitration rules and the terms and agreements of NAFTA, a NAFTA ISDS tribunal found in its award that the ban on the import of MMT violated NAFTA national treatment provision contained in article 1102 which resulted in Ethylreceiving $19.3 million from the Canadian government. Another example includes Bilcon v. Canada, where Bilcon, a US company, wanted to build a marine terminal in an environmentally sensitive region of Nova Scotia which prompted a federal environmental panel to recommend against the project. The ISDS tribunal ruled that the recommendation violated NAFTA’s Minimum Standard of Treatment provision (article 1105) and awarded Bilcon $7 million.

The threat investors constituted for states before ISDS tribunals has led many experts to believe that the mechanism creates a “chilling effect”whereby governments will not act in the public’s best interest due to the fear of investors‘ retaliation. It happens often that governments are not willing to enact certain policies or regulations because they fear these policies or regulations will create a lawsuit before an ISDS tribunal that would result in fines to pay and a negative image towards other future possible investors. The earliest and clearest example of this was in the mid-1990s, when a proposed regulation by the Canadian Parliament to require plain packaging cigarettes was never enacted due to threats from the tobacco industry to bring claims before an ISDS tribunal [6].

The ISDS mechanism has also been criticized for allowing too much lineage to corporations or investors wishing to file a lawsuit. Much of this criticism stems from the fact that many provisions and definitions in the NAFTA agreement are broad, which allows NAFTA ISDS tribunals to loosely interpret them, providing more protection to foreign investors. For example, under article 1139 of NAFTA, the term “investment”has been broadly defined to include debt and equity security, certain types of loans, interest on enterprises, real estate or property, and certain claims to money. Many of the obligation from host states listed in Part A of Chapter 11 have also been criticized for being too loosely defined. One of the most controversial provisions is the Fair and Equitable Treatment (FET) standard contained in article 1105. Article 1105 has been the obligation most frequently invoked by investors in NAFTA investor-state disputes (90% of them) [7].

Although article 1105 says that FET is “in accordance with international law”, many tribunals have expanded the scope of the FET provision to offer more protections to foreign investors [8]. For example, in Merrill & Ring v. Canada, the arbitral tribunal chose to adopt a lower threshold whereby the FET standard “protects against all such acts or behavior that might infringe a sense of fairness, equity and reasonableness”[9]. Two reasons could explain why NAFTA tribunals have been able to expand the interpretation of the FET provision. First, NAFTA tribunals are not required to follow precedent from previous NAFTA investor-state disputes. Second, there is not a strong mechanism that ensures that the FET provision is bound or restricted by international customary precedent.

 

Impact on Future Foreign Direct Investment to Canada

One of the purposes for the creation of the ISDS mechanism was to ensure that foreign investors would be protected from possible volatile or unstable politics of the host state. Therefore, with the implementation of the ISDS mechanism, FDI would increase as there would be less uncertainty in terms of the administration of justice for foreign investors. With the elimination of the ISDS mechanism for Canada, one of the questions that arises is as follows: will FDI from other NAFTA countries to Canada decrease? The answer seems to be negative.

Indeed, FDI into Canada from Mexico and the US has increased substantially since the implementation of NAFTA, but it is difficult to determine whether ISDS were a significant factor in increasing FDI. However, empirical research shows that ISDS, in general, play a minor if not absent role on FDI [10]. For example, some of the largest cross border investments such as between the US and China, do not have a single treaty involving ISDS. Brazil also does not have any investment treaties with ISDS provisions with other countries even though it is one of the largest recipients of FDI. Other countries like India, Indonesia, and South Africa have made efforts to eliminate the ISDS mechanism from their International Investment Agreements which thus far, has not had any substantial effects on their economies. It is also worth noting that the ISDS mechanism is largely encouraged to developing countries where their economy or rule of law is more volatile. All of the countries of NAFTA to a certain extent have well-developed economies and democracies making the ISDS mechanism less necessary.

To sum it up, it can be presumed that the elimination of ISDS will not impact FDI into Canada from the US and Mexico. That will depend on more important factors related to Canada’s economic environment.

Conclusion

Only time will tell whether the change from NAFTA to USMCA will benefit Canada when it comes to investor-state disputes and whether FDI from NAFTA countries to Canada will decrease. However, by analyzing existing information it can be presumed that the elimination of the ISDS mechanism could provide the Canadian government with more political sovereignty and will not affect FDI into Canada from other NAFTA states. If this turns out to be true, it is possible that the elimination of ISDS from investment treaties will become more and more common for states. As a consequence, investors might want to consider the fact that recourses may need to be sought before domestic courts. If investors wish to avoid public litigation, they should anticipate and include tailored ADR clauses in their contracts. For more information and guidance in this regard, please contact the Billiet & Co legal team of experts for assistance at www.billiet-co.be.

By Julien Faucheux, legal intern at Billiet & Co

 

REFERENCES

[1] Seehttps://www.iisd.org/itn/fr/2018/10/17/nafta-2-0-finalized-announced-as-usmca-mexico-united-states-agree-to-limit-isds-clause-canada-to-pull-out-of-isds-after-a-three-year-window, and https://www.nortonrosefulbright.com/en/knowledge/publications/91d41adf/major-changes-for-investor-state-dispute-settlement-in-new-united-states-mexico-canada-agreement
[2] Canada’s Track Record Under NAFTA Chapter 11, Scott Sinclair, North American Investor-State Disputes to January 2018, Canadian Centre for Policy Alternatives, p. 3.
[3] Ibid.
[2].
[4] Ibid. [2], p. 4.
[5]Ibid. [2], p. 8.
[6]Ibid. [2], p. 9.
[7]Ibid. [2].
[8] The Emergence of a Consistent Case Law: How NAFTA Tribunals have Interpreted the Fair and Equitable Treatment Standard, Patrick Dumberry, Kluwer Arbitration Blog, 30 October 2013.
[9] Merrill & Ring Forestry L. P. v. the Government of Canada, ICSID Administered Case, 31 March 2010, ¶210.
[10] Investor-State Dispute Settlement: An Anachronism Whose Time Has Gone, Johannes Schwarzer, Policy Brief 2018/1, Council on Economic Policies.