Investor State Dispute Settlement under NAFTA

Conflict of Laws

Abhijith S R

Roll No 826

Semester V

Abstract

The objective of this paper is to review the formal and informal mechanisms that have been

utilized to resolve trade disputes among NAFTA members. By formal, we refer to the

NAFTA and WTO dispute resolution mechanisms, as well as to national antidumping (AD)

and countervailing duty (CVD) actions. These formal mechanisms are legalistic in the sense

that both the time-tables and the rules of procedure in each stage of the dispute settlement are

strictly specified. These formal mechanisms include both consultative measures and arbitral

panels. Consultative measures attempt to find mutually satisfactory outcomes to disputes.

When consultations fail, countries can resort to arbitral panels, which are designed to be

codified and legalistic.

Introduction

Investor-state dispute settlement mechanisms embodied in most investment treaties provide

rights to foreign investors to seek redress for damages arising out of alleged breaches by host

governments of investment related obligations. The system of investment dispute settlement

has borrowed its main elements from the system of commercial arbitration despite the fact

that investor-state disputes often raise public interest issues which are usually absent from

international commercial arbitration. Investor-state arbitration may often call for

reconciliation of public international law doctrines with the private legal principles of

contract law. This hybrid source of rights is generating new questions and in particular

challenges relating to the quality of awards and jurisdictional issues. Investment arbitration

has expanded in the past decade thanks in part to the more than 2500 BITs now in place

around the world as well as the recently concluded Free Trade Agreements, the NAFTA and

other regional and multilateral investment treaties such as the Energy Charter Treaty. As the

number of investment agreements has risen, the cases brought to dispute settlement have

become increasingly complex too, encompassing multiple contracts and hence multiple

parties and issues. The multiplication of investment agreements with investor-state dispute

settlement provisions has raised the risk of multiple and conflicting awards, as the same

dispute can lead to awards under different treaty regimes, as well as under different contracts.

The more options parties have to resolve their international disputes in different fora, the

greater the risk of multiple and conflicting awards. The North American Free Trade

Agreement (NAFTA) includes impartial, rules-based dispute resolution mechanisms to

provide the assurance of fairness and predictability that North American businesses need to

engage in commercial exchanges. Under NAFTA, our businesses can trade and invest with

the knowledge that rules exist to ensure fair treatment and that procedures are in place to

settle disputes impartially, on the rare occasions when they occur.

Today, the vast majority of trade and investment among the NAFTA partners takes place in

accordance with the clear and well-established rules of NAFTA and the World Trade

Organization. While disputes rarely emerge, NAFTA directs those concerned to try to resolve

their differences through NAFTA committees and working groups or through other

consultations. 

FORMAL DISPUTE RESOLUTION MECHANISMS IN NAFTA

NAFTA created formal mechanisms for solving trade disputes. The principal dispute

mechanisms are provided in Chapters 11, 14, 19, and 20. Chapter 11 covers disputes related

to investment, and Chapter 14 covers disputes related to services. So far, agricultural trade

disputes have been addressed under Chapters 19 and 20 of the agreement. Chapter 19

concerns the application of anti-dumping and countervailing duty laws. Chapter 20 covers

disputes that relate generally to the interpretation or application of NAFTA. Both Chapters 19

and 20 provide for several stages in the process of dispute resolution, beginning with

consultations or mediation among disputing parties. Under Chapter 19, the Agreement

provides for regular consultations where parties can inform interested parties of domestic

antidumping (AD) and countervailing duty (CVD) investigations, and provide them with an

opportunity to furnish information. Once national investigations are complete, parties may

request panel reviews of other parties' final determinations of dumping, subsidization or

injury to domestic industries. Under Chapter 20, consultations occur at the request of a party.

When consultations fail to resolve an issue, parties can request a meeting of the Commission.

The Commission can call on experts, attempt mediation, and make recommendations for the

resolution of the dispute. As a last resort in the dispute settlement process under Chapter 20,

parties may request a panel review of the issues in dispute.

Investment is defined very broadly in article 1139 to include ownership and other interests in

an enterprise, such as equity or debt securities of an enterprise as well as certain loans to an

enterprise. Investment covers interests that entitle an owner to share in the income or profits

of an enterprise; real estate; and all forms of tangible and intangible property, including

intellectual property. The definition of investment also extends to interests arising from the

commitment of capital or other resources such as under concession agreements; turnkey or

construction contracts; or contracts where the remuneration depends on the production,

revenues, or profits of an enterprise such as may occur under license or franchise agreements.

While the dispute settlement mechanisms under the two chapters differ in some details, in

general they are similar in their development of strict rules of procedure and timetables for

panel selection and panel decisions. The rights of each party to choose panelists who are

charged with acting in a neutral, expert, and personal rather than national capacity, and the

use of arguments, submissions and rebuttals are specified. At the close of the review period,

panels issue initial declaratory opinions, along with recommendations for remedial action if

the panel's findings are affirmative. Under Chapter 19, parties may object to or appeal the

panel decision. In this case, an extraordinary panel will reconsider the panel's findings, and

either uphold them or remand them to a newly formed panel. Under Chapter 20, the panel

may reexamine the finding before publishing its final opinion, which is not subject to appeal.

Under both chapters, the resolution of the dispute should be the removal of the offending

practice, but failing that, the offending party must make compensation or the injured party

may take comparable action against the offending party1.

By the time an issue is referred to the Commission, it is not very likely that it can be resolved

without a panel. So far, there have been 4 cases brought into panel reviews under Chapter 19

of the NAFTA, and 2 cases under Chapter 20. Chapter 19 cases involved U.S. malt beverage

exports into Canada, U.S. refined sugar exports into Canada, live swine exports from Canada

into the United States, and fresh cut flowers exported from Mexico to the United States.

Chapter 20 panel reviews covered the interpretation of NAFTA provisions related to

Canadian use of tariff rate quotas (TRQ's) on imports of some agricultural products from the

United States, and the legality of U.S. safeguard action on broom corn brooms from Mexico.

NAFTA members also have the right to pursue actions within the framework of the WTO.

They may pursue any suits relating to matters that are covered by both the NAFTA and the

WTO Agreement, but can pursue a specific issue in only one forum, not both. The WTO has

a panel system similar to that of NAFTA. The global mechanism for resolving trade disputes

was considerably strengthened in the Uruguay Round. Gifford (1997) and Brosch (1998)

1 Gifford, Michael. 1997. "Agricultural Policies, Trade Agreements and Dispute Settlement," in Loyns et al, (eds). Harmonization, Convergence, Compatibility in Agriculture." University of Manitoba. OctoberAvailable At: uoguelph.ca/catprn/PDF-WP/Working_Paper_2007-7.pdf

describe the new credibility that was given to the WTO process in the Uruguay Round by the

decision to prevent parties from blocking panel reports and providing parties with an

Appellate Body review process.2 As in the NAFTA, the offending member must bring its

policies into conformity with the finding, provide compensation, or face retaliatory

withdrawal of concessions. So far, two cases involving disputes among NAFTA parties have

been brought to the WTO. The United States has taken the Canadian fluid milk TRQ and

certain milk pricing practices into dispute settlement at the WTO,3 and has requested a WTO

panel review of Mexico's HFCS duties. Although it pre-dates NAFTA, Canada took the issue

of assumed pass-through of subsidy from live swine to pork to the GATT. This was after

implementation of the Canada-U.S. Free Trade Agreement when there was a choice of forum.

In fact, in that instance, Canada pursued the pass-through issue in the GATT and other

aspects of the live swine countervail under the FTA simultaneously. In addition, there are

other cases, e.g., live cattle, where WTO consultations were initiated but not carried through

to the point of a request for a panel4.

Chapter 11

Chapter 11 of the North American Free Trade Agreement (NAFTA), the investment chapter,

has three objectives: establish a secure investment environment through the elaboration of

clear rules of fair treatment of foreign investment and investors; remove barriers to

investment by eliminating or liberalizing existing restrictions; and provide an effective means

for the resolution of disputes between an investor and the host government. Section A and

annexes I-IV contain exceptions to those obligations as well as commitments for

liberalization of existing restrictions. Section B establishes a dispute settlement mechanism

for resolving claims by an investor that the host government has breached its obligations

under the chapter.

Section A: Substantive Rules and Principles

Section A is built around four principles: (1) national treatment and mostfavored- nation

(MFN) treatment; (2) prohibition of performance requirements; (3) free transfers of profits

2 NAFTA Advisory Committee on Private Commercial Disputes. Available At: http://www.itaiep.doc.gov/nafta/report96.html.3 Text of the North American Free Trade Agreement, available At: http://www.sice.oas.org4 Brosch, Kevin. 1998. "Improvements in WTO Dispute Settlement," in Agriculture in the WTO. Economic Research Service, WRS 98-4. USDA, Economic Research Service. Washington, DC. December. Available At: www.ers.usda.gov/media/1774123/wrs98-4.pdf

and other international payments associated with the investment; and (4) international law

standards on expropriation and compensation.

1. National and MFN Treatment

This is the fundamental obligation of the chapter. Simply put, each Party must treat other

NAFTA investors and their investments no less favorably than it treats its own investors and

their investments (national treatment5) or investors and investments of third parties (MFN

treatment6). A Party is obliged to accord the better of national or MFN treatment.7 Under the

Chapter 11 rules, a precondition for bringing a claim is that a foreign investor has an

investment in the territory of The NAFTA Party against which the claim is brought, and the

claim can be on behalf of the investor itself or of its investment.8 Although there is no

requirement for the exhaustion of remedies before bringing a claim, in bringing such a claim

the investor has to renounce recourse to the domestic courts of The Party against which the

claim is brought.

Tribunals established under NAFTA Chapter 11 are composed of three panel lists, one

appointed by each party and the third, the presiding arbitrator, by agreement of the disputing

parties (the investor and the respondent Party).9In The event of failure to appoint an

arbitrator, or failure to agree on a presiding arbitrator, The Secretary-General of ICSID has

the power of appointment. In accordance with Article 1136, The award of the Tribunal is

binding on both The investor and The respondent Party and any monetary award is to be

enforceable in domestic courts of The respondent Party in accordance with The terms of The

“ICSID Convention10, The New York Convention11 or The Inter-American Convention.12

These treatment obligations apply to all measures relating to the "establishment acquisition,

expansion, management, conduct, operation, and sale or other disposition of investments.”13

In addition to these general provisions, the chapter expressly prohibits certain commonly

encountered forms of discrimination such as requirements that a minimum level of equity be 5 Id. art. 1102.6 Id. art. 1103.7 Id. art. 1104.8 NAFTA Article 1121.9 NAFTA Artides 1116 and 1117.10 Convention on the Settlement of Investment Disputes between States and Nationals of Other States, 18 March 1965, (1965) 41.L.M. 524 (entered moto force 14 Oct. 1966).11 Convention on the Recognition and Enforcernent of Foreign Arbitral Awards, 10 June 1958, (1968) 7 LL.M. 1046 (entered into force 7 June 1959).12 Inter·American Convention on International Cornrnercial Arbitration, 13 Jan. 1975, (1975) 14 LL.M. 336 (entered into force 16 June 1976) [also known as the "Panama Convention"].13 Id.a rts1.1 02, 1103.

held by local nationals, or that certain senior management positions be reserved to local

nationals.14Granting as it does rights to investors to sue the NAFTA Parties directly, Chapter

11 has been controversial within the territories of each of the NAFTA Parties. The fact that a

NAFTA government may have to compensate foreign investors for action it has taken to

achieve environmental objectives has been a particular cause of concern, in part because of

apprehension about a legislative chill in respect of matters otherwise regarded as in the public

interest.15

Prohibition on Performance Requirements

The second main principle is the prohibition on performance requirements. Article 1106

makes clear that no NAFTA country can impose requirements on investors that they export a

certain percentage of output; give preferences for domestic sourcing; achieve a certain level

of domestic content; transfer technology; or achieve a certain trade balance by restricting

domestic sales to some proportion of exports or foreign exchange earnings.

The prohibition on performance requirements serves two goals. First, it eliminates trade

distortions that arise from the imposition of performance requirements. Hence a Party is

prohibited from imposing such requirement even on its own investors. Second, it ensures a

degree of entrepreneurial autonomy: sourcing and sales decisions are based on the investor's

judgment, not by the dictates of the host government. Finally, with respect to performance

requirements, there is a prohibition on certain requirements linked to incentives.'0 The

essence of this provision is that certain performance requirements are so unacceptably trade

distorting or intrusive that host governments should not be able to induce aninvestor to accept

them by conditioning the receipt of any advantage on their fulfillment by the investor.

3. Transfers Relating to Investments

Transfers are the lifeblood of an investment. Article 1109 guarantees that investors can obtain

foreign currency at a market rate of exchange for the purpose of making payments associated

with their investments. This includes transfers to the investor such as the remittance of profits

and dividends, the payment of interest and principal under a loan agreement, royalty

payments, management fees, and proceeds from sale or liquidation of an investment. The

14 Id. art. 1102(4).15 See Julie Soloway, NAFTA's Chapter 11: Investor Protection, Integration and the Public Interest (Institute of Research and Public Policy, Montreal, 2003),

transfers article also applies to payments or transfers by an investment, such as a subsidiary,

to a third party such as payments under a contract for goods or services.

4. International Law Standards on Expropriation and Compensation

Article 1110 addresses nationalization and expropriation of investments. It covers direct,

indirect, and so-called "creeping" expropriation. It provides that investments may not be

expropriated except for a public purpose, on a non-discriminatory basis, in accordance with

due process of law, and upon payment of compensation as specified in the article.

Compensation must be paid without delay, be equal to the fair market value of the

investment, include interest from the date of expropriation, and be fully realizable and freely

transferable as provided in the transfers article.

Usefully, article 1110(2) specifies that valuation criteria should be used that are appropriate

to determine fair market value. For example, one of the criteria listed, "going concern value,"

would be appropriate to determine fair market value in the case of an expropriation of a

business or other ongoing enterprise. Other criteria listed may be appropriate if a single piece

of tangible property or some other discrete asset-as distinct from assets used as part of an

ongoing business-has been expropriated.

Article 1110(8) provides that a non-discriminatory measure of general application would not

be considered a "measure tantamount to an expropriation" of a loan or debt security solely on

the ground that it increases the debtor's general costs of doing business, thus causing it to

default on the debt. Agreement between Mexico and the United States on the expropriation

article effectively ends a difference that has persisted for decades on what compensation is

due in the event of an expropriation.

5. Environmental Provisions

Article 1114 sets forth two provisions highlighting the importance of environmental

protection. Paragraph 1 notes that the chapter should not be construed to prevent a Party from

adopting measures to ensure that investments are undertaken in an environmentally sensitive

manner, provided that those measures are otherwise consistent with the chapter. In paragraph

2 the Parties record their shared conviction that investment should not be encouraged by

relaxing health, safety, or environmental measures.

Limitations to Chapter 11

First, although there is no appeal from the decision of a Chapter 11 tribunal, there is a limited

form of review in accordance with the terms of the ICSIO or Additional Facility Rules or the

UNCITRAL rules, which can be judicially reviewed in the place of arbitration. In the

Metalclad case, this meant review under law of the Province of British Columbia as the seat

of the arbitration." In the review process, the British Columbia court overturned part of the

decision of the tribunal, leading to concerns that domestic courts in Canada might take an

overly intrusive role in reviewing decisions of NAFTA Chapter 11 tribunals. This led the

UPS tribunal to refuse to select a place of arbitration in Canada, even though it was a case

brought against Canada, opting instead of Washington, as the place of arbitration and thereby

avoiding any question of judicial review in Canadian courts. However, subsequent attempts

to have Canadian courts overturn decisions of NAFTA Chapter 11 tribunals have not been

successful and later Chapter 11 tribunal s have selected Canadian jurisdictions as the place of

arbitration.

Second, under Article 1131(2), any interpretation of a provision of the Agreement by the FTC

is binding on a Chapter 11 tribunal. In August 2001, the Commission adopted an

interpretation of Article 1105(1) relating to the minimum standard of treatment to the effect

that this standard was the same as the minimum standard of treatment under customary

international law. At the time that it issued this interpretation, the question of the

interpretation of Article 1105 was before a Chapter 11 tribunal and Article 1105 had been

invoked in other claims. The tribw1al in Pope & Talbot took the view that although it did not

have to decide the matter, it would have the authority to determine whether in issuing the

interpretation the Commission had exceeded its powers. In fact, the tribunal was inclined to

the view that what the Commission had done was to seek to amend the Agreement,

something that as a Commission it did not have the power to do." Subsequent tribunals have

not gone so far, preferring instead the approach of the ADF tribunal that NAFTA Chapter 11

tribunals should accept and not look beyond interpretations of the Agreement made by the

FTC.

Settlement of Investment Disputes

A. STANDING AND JURISDICTION

As part of its NAFTA obligations, each NAFTA country has consented to the submission of a claim to arbitration in accordance with NAFTA procedures.16

16 Id. art. 1122.

Under the investor-state arbitration mechanism an investor of a NAFTA country, on its own

behalf, 13 or on behalf of an enterprise that the investor owns or controls directly or

indirectly, 14 may assert a claim that the investor or the enterprise has incurred loss or

damage as a result of a breach by the host country of a provision of the NAFTA.

APPLICABLE RULES

With certain exceptions and when six months have elapsed since the events giving rise to a

claim, an investor may submit a claim to arbitration under:

(1) the Convention on the Settlement of Investment Disputes between States and Nationals of

other States (ICSID Convention), 8 provided that both the host country and the investor's

home country are parties to the Convention;

(2) the Additional Facility Rules of the ICSID Convention, provided that either the host

country or the investor's country is a party to the Convention; or

(3) the UNCITRAL Arbitration Rules.

The applicable arbitration rules govern the arbitration except as modified by NAFTA rules.

At present, only the United States is party to the ICSID Convention. Hence, only U.S.

investors, or claims against the United States, may be heard under the Additional Facility

Rules.

CONDITIONS PRECEDENT17

An investor may submit a claim for arbitration under the investment chapter only if the

investor (and enterprise, where the claim is submitted on its behalf) satisfies certain

conditions. It must consent to arbitration in accordance with the procedures set out in the

NAFTA. It must also waive the right to initiate or continue before any administrative tribunal

or court under the law of any NAFTA partner, or other dispute settlement procedures, any

proceedings with respect to the measure that is alleged to be a breach of the NAFTA, except

for proceedings for injunctive, declaratory, or other extraordinary relief not involving the

payment of damages.

COMPOSITION OF TRIBUNAL

As a general rule, an arbitration tribunal will comprise three arbitrators, one appointed by

each disputing party and the third (the presiding arbitrator) appointed by agreement of the 17 NAFTA art. 1121.

disputing parties.18 When a tribunal has not been constituted within ninety days from the date

the claim is submitted to arbitration, the secretary-general of the ICSID, on the request of

either party, will appoint the arbitrator or arbitrators not yet appointed.19 When the disputing

parties are unable to agree on a presiding arbitrator, the secretary-general of the ICSID, on

the request of either party, will appoint such arbitrator (who is not a national of either

disputing party) from a roster of forty-five persons appointed by consensus by the NAFTA

Parties, or if no one on the roster is available, from the ICSID panel of arbitrators.

PLACE OF ARBITRATION AND GOVERNING LAW

Unless the disputing parties agree otherwise, an arbitration tribunal will hold the arbitration in

the territory of a NAFTA country that is a party to the New York Convention,20to ensure

enforceability under that Convention.21 An arbitration tribunal must decide the issues in

dispute in accordance with the NAFTA and applicable rules of international law.

CONSOLIDATION OF CLAIMS

One of the novel features of the dispute settlement mechanism is provision for the

consolidation of claims. Thus, where two or more claims submitted to arbitration have a

question of law or fact in common, the claims may "in the interests of fair and efficient

resolution of the claims" be consolidated and heard by a tribunal established under the

UNCITRAL Arbitration Rules, except as modified by the NAFTA.22

ROLE OF THE PARTIES

Section B contains a number of provisions affording a role to the NAFTA Parties in the

interpretation of the chapter. First, a defending state party must provide notice of a claim to

the other Parties and provide copies of the pleadings filed in the arbitration.23Second, a Party

not involved in the dispute may make submissions on a question of NAFTA

interpretation.24Finally, the NAFTA Party against which an arbitration claim is filed may

request the NAFTA Commission (i.e., the three state Parties) to issue a binding interpretation

on whether the measure alleged to be a breach is within the scope of a reservation or

18 Id. art. 1123.19 Id. art. 1124.20 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958), 21U.S.T. 2517, 330 U.N.T.S. 3, T.I.A.S. No. 6997.21 NAFTA art. 1130.22 Id. art. 1126(2).23 Id. art. 1127.24 Id. art 1128.

exception set out in annexes I-IV.25If the Commission fails to submit an interpretation within

sixty days of the request, the tribunal shall decide the issue itself.

INTERIM MEASURES OF PROTECTION AND FINAL AWARD

An arbitration tribunal may order an interim measure of protection to preserve the rights of a

disputing party, or to ensure that the tribunal's jurisdiction is effective, including an order to

preserve evidence in the possession or control of a disputing party or to protect the tribunal's

jurisdiction.26

Section B is drafted so as to permit investors to avail themselves of the enforcement

mechanisms provided in the ICSID Convention, the New York Convention, and the Inter-

American Convention on International Commercial Arbitration.27Article 1122 states that the

consent of the state Party recited in that article together with the submission of a claim by an

investor satisfies the jurisdictional requirements of the three conventions. At the same time,

this section permits enforcement action to be initiated by the state Party whose investor has

received an award.

Conclusion

NAFTA dispute settlement did not turn out the way the negotiators might have intended.

Chapter 20 has been almost moribundo Chapter 19 has not been able to resolve the softwood

lumber issue, and Chapter 11 emerged as a key dispute settlement provision engaging both

Canada and the United States and not just Mexico. In light of this, although it is probably a

generous assessment, dispute settlement under NAFTA might be regarded as a qualified

success. Particularly under Chapters 11 and 19, the mechanisms set up under NAFTA have

provided a forum for the resolution of a relatively large number of disputes, and in that sense

they have fulfilled a need. Moreover, it is difficult to assess whether Chapter 20 is failing to

fulfill a need because the WTO dispute settlement process to a certain extent supplanted it.

While we doubt whether the NAFTA parties are likely to engage in any significant

amendment to any of these processes in any event, on balance we are not convinced that

changes to the existing processes would make any significant difference to the way they

function. As we pointed out earlier, in respect of Chapter 19 some improvement could be

made by changing the extraordinary review process into a fully-fledged appeal process

25 Id. art. 1132.26 Id. art. 1134.27 Id. art. 1136.

although it could change a process from something that is rarely used to something that is

used with regularity. The experience of the WTO Appellate Body suggests that if appeal

processes exist they will be resorted to routinely.

The change from a secretariat based on national sections to a single independent body would

certainly have sorne advantages. It could provide a common secretariat for Chapter 11

disputes although the use of ICSID and recently more frequently the PCA, means the lack of

a NAFTA secretariat for these disputes is not a major problem. However, it is possible that if

such a secretariat had existed a Chapter 20 panel would have been established in the sugar

dispute between Mexico and the USo But, even if that had occurred, it is not elear that this

would have ended that matter. As both the Cross-Border Trucking and the Softwood Lumber

disputes demonstrate, the legal processes of NAFTA are not a panacea for highly politicized

disputes where lack of elarity in legal interpretation is not what fundamentally drives the

dispute.

In any event, as we have pointed out, the question of a united, independent secretariat is part

of a broader discussion of the nature of NAFTA as a free trade agreement and any future it

may have as a different kind of institution. Unless there is a dramatic increase in the use of

the Chapter 20 mechanism, it seems unlikely that the needs of Chapter 20 dispute settlement

would alone justify the development of a single NAFTA secretariat. And Chapter 19 dispute

settlement (apart from Softwood Lumber) has generally functioned well notwithstanding the

inadequacy of the secretariat arrangements.

Finally, in my view, the challenge ahead for NAFTA dispute settlement in its next 15 years,

primarily in relation to Chapter 20 and partly concerning Chapter 19, is one that confronts all

regional free trade agreements. This is to reconcile overlaps with WTO dispute settlement

and determine how conflicts are to be avoided or resolved. In this regard, the matter is less in

the hands of the institutions of the regional free trade agreement and more in the hands of the

dispute settlement bodies of the WTO.