The Regulatory Chill: Balancing Private Investor Rights With Foreign Domestic Policy

Submitted in partial fulfillment for the requirements of the course LAW 724-Legal Aspects of International Business

Prepared by: Karim Kamal Hazime Haj Ali Prepared for: Professor Gil Lan Submitted on: Wednesday November 8th 2012 Total Word Count: 2551

LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 In 2000, a North American Free Trade Agreement (NAFTA) arbitration tribunal awarded Metalclad corp., a Californian-based waste disposal company, approximately $16.7 million in damages against the state of Mexico. 1 The panel found that the Mexican state government of San Luis Potosi had indirectly expropriated Metalclads investment in a waste disposal facility after it designated the surrounding area as an ecological preserve for a rare species of Cacti.2 The tribunal stated that the governmental authorities had breached articles 1105 and 1110 of NAFTA, that being the minimum standard of fair treatment to be provided as well as protection against expropriation without compensation respectively.3 Thus a precedent was set whereby a tribunal could hold a NAFTA member government liable for expropriation of an investors property, even if governmental authorities had done so in a legitimate social and/or environmental manner. This paper will argue that a proper balance ought to be sought, such that private investor rights are protected whilst legitimate regulatory measures enacted by foreign governments are not hampered at the fear of massive arbitral tribunal awards. This paper will also argue that reasonable means towards reform lies within the powers of the Free Trade Commission (FTC) and within the relevant member governments, not the arbitral tribunals.

Metalclad Corp. v. United Mexican States. CASE No. ARB(AF)/97/1. ICSID. 30 Aug. 2000. Web. <https://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC54 2_En&caseId=C155>. At paragraph 131. 2 Ibid. At paragraph 112.
3

North American Free Trade Agreement Between the Government of Canada, the Government of Mexico and the Government of the United States, 17 December 1992, Can. T.S. 1994 No. 2, 32 I.L.M. 289 (entered into force 1 January 1994) [NAFTA] arts.1105, 1110.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 NAFTA was declared in full force and effect on January 1st 1994.4 Chapter 11 of NAFTA was designed to promote investment among the member countries and mainly dealt with investor-state dispute resolution. The National Treatment rule and Most Favored Nation status are enshrined within articles 1102 and 1103 respectively. Moreover, a procedure for adjudication via a tribunal was established under section B of this chapter, such that parties to a dispute can remedy potential breaches of any of the underlying provisions.5 These provisions are substantially similar to the Organization for Economic Co-operation and Development (OECD) draft convention on the protection of foreign property. 6 However, what was considered unique about these investment protection provisions was that they dealt with multiple developed countries with a great amount of investment occurring between them. 7 It should be noted that expropriation itself is not prohibited by NAFTA or by any other rule of international law for that matter. Rather, expropriation under article 1110 is allowed so long it is done for a public purpose; on a non-discriminatory basis; in accordance with due process of law and article 1105; and on payment of just compensation.8 NAFTA does not actually expressly define the term expropriation, therefore much of the chapter 11 disputes revolve around the meaning of this term.
4

Nicholson, Mary Jo. "Chapter 5 Introduction." Legal Aspects of International Business: A Canadian Perspective. 2nd ed. Toronto: Emond Montgomery, 2007. 117-18. Print. 5 Supra, note 3 Arts. 1102, 1103 and Section B.
6

Elcombe, Joshua. "Regulatory powers vs. investment protection under NAFTA's Chapter 1110: Metalclad, Methanex, and Glamis Gold." University of Toronto Faculty of Law Review Winter 2010: 71+. Academic OneFile. Web. 3 Nov. 2012. At Part II. 7 Supra, note 4 at page 149.
8

Supra, note 3.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 Recall that under the Metalclad case, the Tribunal found that the regulatory measures enacted by the Mexican authorities where tantamount to expropriation and as such full compensation was to be granted to Metalclad Corp. Later on, at the request of the Mexican government as in accordance with the provisions of the arbitral rules, the BC Supreme Court reviewed the decision. The court stated that the Tribunal had erred in its finding by holding the government of Mexico to a very strict standard of treatment as per article 1105 that in turn breached article 1110.9 Justice Tysoe however did not reverse the fundamental findings of the Tribunal but instead held that the actions of the Mexican government amounted to a direct expropriation and as such confirmed the awarded damages for compensation. The court concluded that the Tribunal gave expropriation a very broad meaning when it defined it as: " Interference with the use of property which [deprives] ... in significant part, of the use or reasonably-to-be-expected economic benefit of property"
10

As such this

definition could even include legitimate rezoning by a governmental authority. The Tribunal considered the Sole-Effect that a regulatory measure has on an investors expropriated property. Following that reasoning, nearly any

government measure that substantially diminishes the value of an investment (regardless of its purpose) could amount to a breach of article 1110 expropriation without compensation. 11 On a broader note, article 201 of NAFTA defines measure to include: any law, regulation, procedure, requirement or
9

United Mexican States v. Metalclad Corporation, 2001 BCSC 664 at para. 79. Ibid. at para. 99.

10 11

"Private Rights, Public Problems; A Guide To NAFTA's Controversial Chapter On Investor Rights." IISD, 2001. Web. <http://www.iisd.org/pdf/trade_citizensguide.pdf>. at page 32-33.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 practice.12 That coupled with the definition of investment, seems broad enough to include any government action and/or policy as well as any form of enterprise and property. Having mentioned all of this, the Tribunal seems to have rejected the Police-Powers doctrine, which holds that non-discriminatory government measures implemented for a public purpose are not tantamount to

expropriation.13 Despite the fact that a Tribunal does not have the power to strike down a NAFTA countrys domestic legislation, the threat of an investor suit under chapter 11 (and article 1110 especially) may discourage legal authorities from enacting valid and legitimate regulatory measures. A subsequent recent decision falling under NAFTA chapter 11 can be found in Glamis Gold Ltd. v. The United States of America .14 Glamis Imperial, a wholly owned subsidiary of Glamis Gold (a Canadian company), invested a significant amount of money in order to acquire mining permits for exploration of numerous sites within the state of California. During that time, the Californian senate had passed Senate Bill-22 that banned mining anywhere within a mile of property designated as a Native American ritual site without undertaking extensive measures to restore the site to its original physical condition. 15 In addition, regulations were also enacted requiring mining site reconstruction at an open pit mine.16 The company had discovered, prior to the enactment of Senate

12 13 14

Supra. Note 3 art. 201. Supra note 11 page 31.

Glamis Gold Ltd. v. United States of America. ICSID. 8 June 2009. <http://italaw.com/documents/Glamis_Award.pdf>.
15 16

Ibid, at para. 166 & 175. Ibid, at para 181.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 Bill-22, that its operations overlapped property central to the Quechan aboriginal tribe's religious rituals.17 Glamis Gold initiated proceedings under article 1110 of NAFTAs chapter 11, claiming that Californias Senate Bill had rendered its investments economically infeasible. 18 The U.S. government responded by stating that non-discriminatory government measures implemented for a public purpose are not tantamount to expropriation, hence utilizing the Police-Powers doctrine in its defense. 19 In deciding in whether an unjust expropriation was present, the Tribunal assessed the magnitude of the harm towards Glamiss investment relative to its total value. Despite the fact that Senate Bill-22 imposed additional costs of compliance on Glamiss operations, the mining project still remained a profitable opportunity for the company and as such an article 1110 expropriation did not apply. " A State is not responsible however 'for loss of property or for other economic disadvantage resulting from bona fide ... regulation'." 20 However, in a somewhat unreasonable manner, the tribunal switched its focus to a threshold examination to analyze the extent of damage done to the investment.21 Again, similar to Metalclad, the key factor in deciding whether expropriation was present was the extent of damage done to the investment and not the underlying government rationale in passing Senate Bill22. Although the Californian governments rationale for passing the bill was clearly articulated and done in a public purpose, the Tribunal was able to avoid
17 18 19 20 21

Ibid, at paras. 103-108. Ibid, at para. 11. Supra, note 6 at Part VII. Supra, note 14 para. 354. Supra, note 14 para. 356.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 analyzing it by deciding the case on a narrow issue of valuation. Although the Glamis Gold claims were dismissed and no damages were awarded,22 the threat of Metalclad was still present. NAFTA is not the only Free Trade Agreement (FTA) within the Americas that is hotly debated as per its investor-state dispute resolution provisions. In 2005, then senator Barack Obama, wrote an opinion piece in which he opposed the Dominican Republic-Central American Free Trade Agreement (CAFTA-DR), stating: [the agreement did] little to address enforcement of basic environmental standards in the Central American Countries. 23 Article 11 of NAFTA, which allowed for the Metalclad judgment, is also prevalent within CAFTA. In fact, CAFTA is largely a word-for-word duplicate of NAFTA.24 Katie Zaunbrecher argues that the CAFTA investor suit provisions can and will result in a regulatory chill, to the extent that sovereign nations would refrain from implementing sound environmental and social policies due to: fear of potentially crippling damages [as an] award for indirect expropriation. 25 The latest ongoing investor suit that falls under CAFTA-DR can be found in Pac Rim Cayman LLC v. The Republic of El Salvador.26 In 2009, the Canadian company Pacific Rim Corp. (PRC) initiated arbitration proceedings against the government of El Salvador sighting discriminatory conduct; lack of transparency and unfair

22 23 24

Supra, note 14 para 831. Barack Obama, Op-Ed, Why I Oppose CAFTA, CHI. TRIB., June 30, 2005, at para. 27.

Zaunbrecher, Katie. "Pac Rim Cayman v. Republic of El Salvador: confronting free trade's chilling effect on environmental progress in Latin America." Houston Journal of International Law Spring 2011: 489+. Academic OneFile. Web. 25 Ibid.
26

Pac Rim Cayman LLC v. The Republic of El Salvador. ICSID CASE NO. ARB/09/12.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 treatment causing a breach of article 10.39 of CAFTA-DR. PRC is seeking $100 million in damages after the El Salvadoran governments failure to issue it a mining permit for the companys El Dorado gold mine.27 The case is currently in the final stages of arbitration at the International Center for the Settlement of Investment Disputes (ICSID) and looks to be heading in favor of PRC.28 What is more interesting is the fact that PRC is a Canadian company and thus does not fall under the jurisdiction of CAFTA-DR. PRC reincorporated its Cayman island subsidiary and transferred its mine to this newly created U.S. entity thus allowing it to utilize CAFTA-DR article 10.29 Therefore, troubling questions are raised for the future of FTAs and environmental and social responsibilities within the Americas. In her article on the aforementioned ongoing events, Katie Zaunbrecher concludes by stating: How much of an incursion on sovereign authority is acceptable when economic development and foreign trade are on the line? Should future FTAs provide the investor-state dispute resolution loophole that allowed the strategic maneuvering mastered by Pacific Rim/Pac Rim? And at what point do FTAs stop paying lip service to environmental aspirations and actually start achieving them?30 Critics may argue that the threat of Metalclad has been reduced due to the subsequent Tribunal decision found in Methanex Corporation v. United States of

27

"Pacific Rim Files Notice of Intent to Seek CAFTA Arbitration." Pacific Rim Mining Corp. Pacific Rim Resources, 9 Dec. 2008. Web. <http://www.pacrimmining.com/s/News.asp?ReportID=364982>. 28 Pacific Rim Mining Negotiates Set Fee Structure for Final Phase of ICSID Arbitration. Pacific Rim Mining Corp. Pacific Rim Resources, 25 Oct. 2012. Web. <http://www.pacrimmining.com/s/News.asp?ReportID=553990>. 29 "Witness Statement of Thomas C. Shrake." International Center for the Settlement of Investment Disputes. 31 Dec. 2010. Web. At para. 113 <http://italaw.com/documents/WitnessStatementThomasCShrake31Dec2010.pdf>. 30 Supra, note 24.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 America, which apparently reversed the decision found in Metalclad.31 The fact scenario revolved around the banning of a methanol based fuel additive, MTBE, by the Californian government. Methanex, a Canadian company and the worlds largest producer of methanol, alleged that the ban amounted to an expropriation of a large part of its business.32 The Tribunal held that the U.S. government was not required to compensate Methanex for enacting environmental regulations in: a non-discriminatory [manner] for a public purpose enacted in due process [in a non]-expropriatory and compensable [manner]. 33 It should be noted however, that the principle of stare decisis does not apply in the international trade law context. Just how Methanex ignored Metalclad, Glamis Gold ignored Methanex. Moreover, in reaching its decision, the Tribunal in Methanex stated: Methanex's central claim under Article 1110(1) of expropriation under one of the three forms of action in that provision fails." 34 The mention of the three forms of action may suggest that the Tribunal erred in its interpretation of article 1110(1) a), b), c) and d). The panel indeed overlooked the fact that all four subsections are required for article 1110(1) to take effect. Instead the arbitrators seem to have interpreted subsection (d) as a remedial provision that is activated once the three previous subsections are triggered. 35 On the contrary, it is article 1135 of NAFTA that sets out the available remedies

31

Methanex Corporation v. United States of America (Final Award of the Tribunal on Jurisdiction and Merits) (2005), 44 I.L.M. 1345 (Ch. 11 Panel) 32 Ibid, at part II para. 2-4 & 31.
33 34 35

Ibid, at part IV para. 7. Ibid, at part IV para. 15. Supra, note 6 at part VI.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 once a breach of article 11 is confirmed.36 The Methanex Tribunal's approach raises serious legitimacy concerns the Panel actually contradicted Chapter 11's text.37 It can be argued that the problems discussed thus far are actually inherent in NAFTAs chapter 11 and article 1110 and not due to inadequate legal reasoning on behalf of the Tribunals. The Free Trade Commission (FTC), a body comprised of the three trade ministers from the NAFTA member countries, has the interpretive power to potentially correct the ongoing debate over article 1110 and the breadth of the term expropriation.38 Article 1132(2) grants the FTC the power to issue binding interpretations on the tribunals. 39 Although interpretive statements require unanimity among all three-trade ministers, the procedure is relatively informal and is different from the formalities of legislative procedure, thus potentially prone to less resistance from the domestic legislature of the member countries.
40

In fact, the FTC has previously released notes of

interpretation in 2001 that dealt with surrounding confusion of article 1105 during that time.41 The FTC should act in the same manner it did more than a decade ago, by specifying that regulatory measures enacted by member countries for environmental and social reasons are not tantamount to expropriation and as such are not covered by article 1110 of NAFTA. The FTC is a political institution

36 37 38 39 40 41

Supra, note 3 art. 1135. Supra, note 6 at part VI. Supra, note 6 at part VIII. Supra, note 3 art. 1131 and 1132. Supra, note 6 at part VIII. Supra, note 6 at part VIII.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 and as such ought to give: policy considerations greater weight than concern for conceptual accuracy.42 In conclusion, the Metalclad threat still lingers. The only feasible way the regulatory chill can be thawed (so to speak) is by expedient action from the FTC and its interpretive powers. If ICSID finds in favor of PRC, then this will only serve to strengthen the effect that Metalclad has had on the Americas from more than a decade ago. Immediate action ought to be taken for the greater good of trade and the planet we call our home.

LEGISLATION
North American Free Trade Agreement Between the Government of Canada, the Government of Mexico and the Government of the United States, (entered into force 1 January 1994) [NAFTA] Dominican Republic-Central American Free Trade Agreement Between the Government of Costa Rica, the Government of El Salvador, the Government of Guatemala, the Government of Honduras, the Government of Nicaragua, the Government of The Dominican Republic, and the Government of The United States, (Fully in force among all countries by January 1, 2009) [CAFTA-DR]

JURISPRUDENCE
42

Supra, note 6 at part VIII.

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 Metal Clad Corporation v. United Mexican States (ICSID Case No. ARB/7/1) United Mexican States v. Metalclad Corporation, 2001 BCSC 664 Glamis Gold Ltd. v. United States of America. ICSID. 8 June 2009 Pac Rim Cayman LLC v. Republic of El Salvador (ICSID Case No. ARB/09/12) Methanex Corporation v. United States of America (Final Award of the Tribunal on Jurisdiction and Merits) (2005), 44 I.L.M. 1345 (Ch. 11 Panel)

SECONDARY MATERIAL: BOOKS

Nicholson, Mary Jo. "Chapter 5 Introduction." Legal Aspects of International Business: A Canadian Perspective. 2nd ed. Toronto: Emond Montgomery, 2007. 117-18. Print.

SECONDARY MATERIAL: ARTICLES

Cavooris, Robert. "Obamas Final Stopover: Ignoring CAFTA Protests in San Salvador."Council on Hemispheric Affairs. (March 2011). Online: Coha.org <http://www.coha.org/obama%E2%80%99s-final-stopover-ignoring-caftaprotests-in-san-salvador/>. Elcombe, Joshua. "Regulatory powers vs. investment protection under NAFTA's Chapter 1110: Metalclad, Methanex, and Glamis Gold." University of Toronto Faculty of Law Review Winter 2010: 71+. Academic OneFile. Web. 3 Nov. 2012. Pacific Rim. "Pacific Rim Files Notice of Intent to Seek CAFTA Arbitration." (December 2008). Online: pacrimmining.ca <http://www.pacrimmining.com/s/News.asp?ReportID=364982>. Pacific Rim Mining Negotiates Set Fee Structure for Final Phase of ICSID Arbitration. Pacific Rim Mining Corp. Pacific Rim Resources, 25 Oct. 2012. Web. <http://www.pacrim-mining.com/s/News.asp?ReportID=553990>. "Private Rights, Public Problems; A Guide To NAFTA's Controversial Chapter On Investor Rights." IISD, 2001. Web. <http://www.iisd.org/pdf/trade_citizensguide.pdf>. "Witness Statement of Thomas C. Shrake." International Center for the Settlement of Investment Disputes. 31 Dec. 2010. Web. At para. 113

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LAW 724 Legal Aspects of International Business; Midterm Essay FALL 2012 <http://italaw.com/documents/WitnessStatementThomasCShrake31Dec2010.pdf >. Zaunbrecher, Katie. "Pac Rim Cayman v. Republic of El Salvador: Confronting Free Trade's Chilling Effect on Environmental Progress in Latin America." (2009) Houston Journal of International Law.

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