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Investor vs. State

Policy Alternatives | 1 July 2015

Investor vs. State

Canada is being pummeled by NAFTA corporate lawsuits. Why do we put up with it?

Scott Sinclair

A system that empowers corporations to sue governments for compensation whenever they feel a policy or decision has interfered with their expected profits sounds like something out of a dystopian future. Sadly such a system already exists—in a web of thousands of international investment treaties—and Canada is a regular (and strangely willing) target.

When the North American Free Trade Agreement (NAFTA) came into force 21 years ago, there was plenty of debate about its likely impact on jobs, energy and sovereignty. The environmental movement of the day nearly scuttled the deal on fears it would severely curtail the ability of governments to set strong environmental protection and conservation policies. But these groups were split down the middle by a government proposal for what we can now conclusively call a useless environmental side-agreement, paving the way for NAFTA’s ratification.

Unfortunately, at the time much less attention was paid to an obscure investor–state dispute settlement (ISDS) provision in the treaty’s investment chapter. It set up a process through which foreign investors could choose to settle disputes with government through binding private arbitration instead of national courts. The dubious rationale for granting this extraordinarily sweeping right to foreign investors was that Mexican courts were prone to corruption and political interference.

Over two decades later, the ISDS process in NAFTA has become notorious, more so elsewhere than in Canada, though this is changing. Of the 78 investor–state claims filed to date under NAFTA only a handful pertain to the administration of justice in the Mexican courts. Instead, foreign investors targeted a broad range of government measures in North America—especially in the areas of environmental protection and natural resource management—which allegedly impaired corporate profits. Canada has faced 36 ISDS claims, more than any other developed country in the world, and since 2005 we’ve been hit by 70% of all NAFTA investor lawsuits.

Despite this bruising experience and grim prospects the federal government is hell-bent on expanding ISDS in pending international trade agreements, including treaties with the European Union (EU) and the U.S.-led Trans-Pacific Partnership (TPP). Critics, whose ranks are growing, are left wondering why their government continues to give private, for-profit arbitrators the power to interpret treaties, to decide over questions of public law and to impose fines paid from public funds.

The situation is truly outrageous. Two recent NAFTA defeats for Canada help us understand exactly why. These cases vindicate long-standing criticisms of investment arbitration in trade and investment agreements. Unfortunately, unless the federal government changes course, they will be neither isolated occurrences nor the last such cases Canada will endure.

Mobil and Murphy vs. Canada

In March, Exxon Mobil’s Canadian subsidiary and a smaller company, Murphy Oil, jointly won $17.3 million in damages after successfully challenging requirements that companies in the offshore oil sector dedicate a tiny percentage (0.33%) of their revenues to research and development, education and training within the province of Newfoundland and Labrador. It is bad enough that under NAFTA it is illegal to oblige one of the world’s most profitable corporations—Exxon Mobil earned US$4.94 billion in the first quarter of 2015 despite the downturn in oil prices—to contribute to the local economy in return for access to publicly owned natural resources. But what is especially galling about this case is that Exxon, along with every other company active in the offshore oil sector, had explicitly agreed to abide by provincial R&D commitments. What’s more, the provincial and federal governments had assumed quite reasonably these conditions had been exempted from NAFTA.

Newfoundland and Labrador has a history of massive resource projects that bring few benefits to the province and its residents. Determined not to repeat this in the offshore oil sector, in the mid-1980s the province negotiated the Atlantic Accord with the federal government to ensure benefits would accrue to the local economy. Canada filed a reservation (exclusion) under NAFTA that supposedly protected the accord from trade or investment disputes related to its performance requirements (e.g., local content and minimum investment quotas), which are otherwise banned by the free trade deal’s investment chapter.

But, in 2012, the NAFTA tribunal rejected Canada’s legal arguments that the R&D guidelines fell within the scope of the Canadian reservation for benefits plans under the authority of the Canada–Newfoundland Atlantic Accord Implementation Act.& In 2004, those requirements had been toughened after the offshore petroleum board concluded that companies were not meeting their existing R&D pledges. The tribunal, with one arbitration lawyer in dissent, took the very narrow view that the accord and any subordinate measures were excluded from coverage only exactly as they existed in 1994 when NAFTA took effect. No changes could be made to strengthen them, and the discretionary authority under the act, which both Canada and the provincial government had reasonably assumed was protected, could not be exercised to make the R&D requirements more effective.

This restrictive ruling calls into question the efficacy of other Canadian federal and provincial reservations, not only under NAFTA, but also in the pending Canada-European Union Comprehensive Economic and Trade Agreement (CETA) and the TPP. These reservations, of which there are hundreds, are supposed to protect governmental authority in areas ranging from Saskatchewan’s limits on foreign ownership of farmland to Ontario’s requirements that timber from public lands be processed within Canada. The Mobil/Murphy ruling casts serious doubts about whether these reservations can actually be relied on in a dispute, and it drives home the point that investor–state tribunals will interpret investor rights broadly and exceptions narrowly.

In another harmful twist, the March 2015 ruling, which decided how big a fine Canada had to pay the two U.S. oil companies, determined that so long as the R&D guidelines remain in place, Canada is in “continuing breach” of NAFTA and damages continue to accumulate. The tribunal’s $17 million award only covered damages until 2012. Exxon Mobil has now filed a new claim for ongoing damages since then.

Proponents of investment arbitration frequently assert that the system does not and “cannot require countries to change any law or regulation,” in the words of a recent White House statement. While this is true strictly speaking, investment panels can require governments to pay compensation, and these awards are fully enforceable in domestic courts. As the Mobil/Murphy case shows, the tribunal can order ongoing damages for as long as governments retain the offending measure. Practically speaking, few governments can tolerate this situation and will change the offending measure. Given the clear evidence to the contrary, it is specious to argue that democratic authority remains unaffected by ISDS. The Canadian government’s repeated and emphatic assurances that regulatory authority has been protected are simply smokescreens designed to fool the public.

Bilcon vs. Canada

A second disturbing NAFTA loss directly contradicts repeated federal government claims that NAFTA and other free trade and investment deals “do not compromise the environmental protection measures that Canada has implemented.”In March, a NAFTA tribunal ruled that a joint federal-provincial environmental assessment, which led to a U.S. firm being denied a permit to build a massive quarry in a sensitive coastal area in Nova Scotia, violated the company’s NAFTA investor protections. The U.S. investor, Bilcon, is now seeking over $300 million in damages from the federal government.

In 2007, after three years of extensive study and public consultation involving all interested parties, a joint federal-provincial environmental assessment panel recommended against the quarry and related marine terminal due to their negative environmental and socioeconomic effects. The governments of Nova Scotia and Canada accepted that recommendation, denying approval for the controversial project. It was a rare move for a federal panel, illustrating the seriousness of the environmental concerns.

Bilcon did not appeal any decisions related to the project thorough the domestic courts, even though it had the right to pursue a federal court review of the environmental panel’s finding. Instead, and with the help of Canadian lawyer Barry Appleton, it bypassed the Canadian courts and went directly to NAFTA investor–state dispute settlement. The NAFTA tribunal ruled 2-1 that both the environmental assessment process and the subsequent decision to block the project violated the firm’s NAFTA guarantees to minimum standards of treatment and national treatment.

Though no Canadian court had ruled on the matter, the NAFTA tribunal determined that the environmental assessment panel had violated Canadian law. The majority on the tribunal felt the criterion of “community core values,” which it construed as the primary basis of the environmental assessment panel recommendation against the project, was outside the panel’s legal mandate. They also condemned the environmental panel’s decision to recommend against the project outright without suggesting changes that might have mitigated its negative impacts and allowed Bilcon to proceed.

The minimum standard of treatment protections in NAFTA and other treaties have been rightly criticized as inherently subjective, allowing arbitrators to apply their own preferences and prejudices. Without a doubt, the Bilcon ruling validates these concerns. The tribunal, chaired by a German jurist, was not qualified to judge whether or not Canadian law had been broken. According to many experts, the majority’s interpretation of Canadian law was almost certainly wrong. The tribunal “lacked, with the exception of the dissenting member, even a basic understanding of the legal context within which the decisions it was asked to rule on where made,” according to environmental law professor Meinhard Doelle.

NAFTA chapter 11 gives private for-profit arbitrators the power to usurp the role of the Canadian courts, which were precluded from ruling on this matter because of the investor’s own decision to bypass them. This travesty of justice exemplifies how the ISDS regime privileges foreign investors, elevating them above citizens, legislatures and the courts in violation of the basic principle of equality before the law.

Yet, as the tribunal’s dissenting member also stressed, even if federal environmental assessment legislation had not been followed to the letter (which was unproven), this should never have been deemed a violation of NAFTA’s guarantees of minimum standards of treatment under customary international law. It is the position of all three NAFTA governments that such standards should be interpreted cautiously and only in cases involving the most egregious state conduct.

The Bilcon majority’s ruling that the federal and Nova Scotia governments violated NAFTA’s national treatment (non-discrimination) rule is also deeply worrying. It equates cases where investors are treated differently to full-fledged discrimination based on nationality. Governments frequently treat investors differently for perfectly legitimate reasons. An investment in an environmentally sensitive region, for example, may be treated differently than an investment in another less fragile or more highly industrialized area, whether the investor is a foreign corporation or a Canadian entity.

The NAFTA tribunal scrutinized examples of what it considered to be comparable projects involving Canadian investors in quarries or marine terminals that had either not been subject to full environmental assessment, approved with mitigation measures or approved outright. This satisfied two arbitrators, with the third again disagreeing, that Bilcon had been treated less favourably in violation of the national treatment rule.

Deciding if the proponents (investors) of completely unrelated projects were treated better or worse is difficult and inherently subjective. The tribunal’s decision to equate different, allegedly less-favourable treatment with nationality-based discrimination is troubling. This ruling demonstrates in graphic terms how ISDS enables private arbitrators to hold elected governments to impossible standards of consistency whereby any difference in treatment can be likened, at the arbitrator’s discretion, with nationality-based discrimination. Democratic regulation is paralyzed by such presumption.

The environmental assessment panel did its job thoroughly and professionally. It acted well within the legal mandate established jointly by the provincial and federal governments. Its well-reasoned and considered recommendations were welcomed by the majority of residents and acted upon by both levels of government. But the NAFTA ruling has now tainted this all-too-rare victory for environmental protection.

While Bilcon did not get to build its massive quarry, the NAFTA ruling won by the U.S. investor has blown a huge hole in the Canadian environmental assessment process. The dissenting member of the tribunal objected to the majority’s ruling as being a "significant intrusion into domestic jurisdiction” that “will create a chill on the operation of environmental review panels." Fittingly, he described it as “a remarkable step backwards” for environmental protection. Unless this ISDS threat is removed, the prospect of second-guessing and punitive monetary damages will cripple future environmental assessment panels, which have already been considerably weakened by Canada’s current federal government.

Pro-ISDS propaganda contradicted by facts

The federal government has barely reacted publicly to either of these troubling NAFTA rulings. A spokesperson for Foreign Affairs, Trade and Development told CBC in late March only that Canada was “disappointed” by the Bilcon decision. The government said it would consult the two provincial governments involved (Newfoundland and Labrador, Nova Scotia) on how to proceed in the face of the Exxon/Murphy and Bilcon losses.

In the wake of these defeats, it should be impossible for the federal government to credibly maintain its insistence that ISDS “does not restrict any level of government from legitimately legislating in the public interest” and that it does not compromise environmental protection or other important public policy objectives. Unfortunately, there is even more pain to come.

Canada currently faces eight pending investor–state claims involving some highly sensitive regulatory matters. In addition to the second claim by Exxon Mobil for ongoing damages, these suits challenge a ban on fracking by the Quebec provincial government (Lone Pine), a decision by a Canadian Federal Court to invalidate a pharmaceutical patent on the basis that it was not sufficiently innovative or useful (Eli Lilly), provisions to promote the rapid adoption of renewable energies (Mesa—another Appleton case), and a moratorium on offshore wind projects in Lake Ontario (Windstream). Total penalties sought in just these five cases: about $2 billion.

Legal arguments are now being heard by NAFTA tribunals in the Lone Pine and Eli Lilly cases. A final ruling on the Mesa case involving a challenge to the Ontario Green Energy Act is expected at any time. In many of these pending claims, foreign corporations stand a realistic chance of success. In fact, extrapolating from Canada’s past track record, claimants can reasonably be expected to win about half of these ongoing cases. This will surely add to Canada’s current tally of seven lost or settled claims and damages totalling over $190 million.

Abuses of ISDS in NAFTA chapter 11 are reaching crisis proportions. Rationally, Canada should be seeking to disengage from this system. Instead, the current federal government is not only still defending ISDS, it is expanding its use. With investor–state arbitration included in CETA, the TPP and dozens of Foreign Investment Protection Agreements (FIPAs) such as the Canada-China deal (see Gus Van Harten on page 24), the share of foreign investments in Canada eligible to bring investor–state claims will increase from 55% under NAFTA to nearly 90%. This is throwing oil on the fire.

In the case of CETA, Canada’s current federal government remains strongly committed to investment arbitration even when a significant number of European governments, including powerhouses such as Germany and France, would be happy to drop it from the agreement. A golden opportunity for sane second thought is passing us by.

In the absence of federal leadership, provincial governments have an important role to play. All provincial and territorial governments should review and hopefully revoke support for ISDS. Nova Scotia and Newfoundland and Labrador should stick to their position that the federal government alone must shoulder the costs of the NAFTA fines. Newfoundland and Labrador should also refuse to change its regional development requirements in the Atlantic Accord despite the ongoing pressure of Exxon’s lawsuit. The prospect of mounting financial and legal liabilities could pressure the federal government to change its approach to ISDS.

The silver lining to the recent NAFTA losses could be that the costs of the Canadian government’s ideological commitment to investment arbitration, both financially and in public policy terms, are becoming clearer to more and more citizens. There is a powerful and growing global backlash against ISDS. Alarmed by increasingly aggressive recourse to investor–state arbitration by corporations challenging public policy and regulatory measures, including many cases from Canadian mining and resource firms (see Hadrian Martin-Kirkwood on page 30), governments around the world are seeking to extricate themselves from this anti-democratic feature of modern trade and investment treaties. There is no good excuse why Canada shouldn’t join them.

Scott Sinclair is a senior research fellow with the CCPA and the director of the organization’s Trade and Investment Research Project.

 source: Policy Alternatives