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Explicit Obligations

Under Canadian constitutional arrangements, federal authority to implement a treaty is limited to matters that fall within its sphere of constitutional competence. Nevertheless, many NAFTA and WTO disciplines explicitly refer to the obligations of provincial and municipal governments. Furthermore, Canada is bound under international law by such commitments even where they fall exclusively within the domain of provincial constitutional authority. While provincial and municipal governments may not as a matter of strict constitutional law be bound by these obligations, there are several reasons why it would be very difficult for them to ignore these “non-binding” obligations.

All Necessary Measures

To begin with, the federal government is obliged under Article 105 to:

… ensure that all necessary measures are taken in order to give effect to the provisions of this Agreement, including their observance, except as otherwise provided in this Agreement, by state and provincial governments.

It is unclear what “all necessary measures” might mean given the particular features of Canadian constitutional arrangements. A reduction in federal transfer payments, program support, or infrastructure funding represent obvious examples of the steps that might be taken by Canada to honour its obligations under this Article.

However, pressure on the province to comply with Canada’s international trade and investment obligations is probably most easily exerted behind closed doors. Here the federal government enjoys the considerable leverage associated with having to defend provincial interests in the international sphere. Examples such as the Pacific Salmon Treaty and the Softwood Lumber Agreement illustrate the dependence of the province’s economy on the federal government to champion provincial interests. Furthermore, BC’s reluctance to comply with its explicit obligations under NAFTA and the WTO would not be lost on its trading partners who have the capacity to strategically target BC interests with retaliatory trade sanctions.

It is simply not realistic, in our view, to imagine that the province could ignore an adverse trade ruling or damage award arising from its failure to observe the constraints imposed by NAFTA or WTO agreements. In other words, the dependence of the provincial economy on international trade and the inter-dependence of provincial and federal agendas when it comes to trade and investment impart a de facto obligation on the province to honour the commitments made by the federal government.

Finally in this regard, any lingering doubts there might have been about the application of international trade regimes to municipalities have now been put to rest by international investor claims that have specifically targeted local government.

Metalclad Inc. vs. Mexico [ICSID Additional Facility Rules]

Closest to home is the recent judgment of the BC Supreme Court in an appeal by Mexico of a NAFTA award that it pay more than $U.S. 16 million in damages to a U.S. hazardous waste company - Metalclad Corporation. The judgment was the first in any NAFTA jurisdiction to review an award made pursuant to the Treaty’s investment rules.

The Tribunal that decided the Metalclad claim ruled that a local municipality had no right to deny the company a permit to built a hazardous waste facility because of environmental and public health concerns, or because the company had built much of its project before applying for a local construction permit. Ignoring the evidence of Mexico’s constitutional law experts, including the ex-chief justice of the Supreme Court, the tribunal ruled that the local government had acted beyond its authority in refusing a permit on these grounds. By doing so, the Tribunal concluded that it had expropriated the company’s investment.

The tribunal also found Mexico in breach of its obligations under Article 1105 of NAFTA, which obliges it to accord foreign investments treatment in accordance with international law. The Tribunal faulted Mexico for failing to provide a more transparent regulatory process for a project that would be just as fraught with legal controversy in Canada or the United States.

Finally, the Tribunal objected to a decision by the state government to establish an ecological preserve that included the company’s site. In its view, this also represented an unlawful taking of Metalclad’s property.

In passing, the Tribunal left no doubt about the obligations of the federal government for the actions of local government, reminding Mexico of its obligations under Article 105, and going even further by imposing on the federal government a positive obligation to interfere with the exercise of municipal government authority where a complaint is made that the local government was acting in breach of NAFTA provisions.

Mexico’s appeal provided a critical test of how our courts would deal with NAFTA-based arbitral awards. While the Judge had some critical things to say about the way the Tribunal went about its work, he ultimately found in favour of the company and sustained the damage award, subject only to a modest adjustment.

The most troubling aspect of Mr. Justice Tysoe’s ruling was his decision to show the Tribunal’s decision the same deference that is common to awards arising from private commercial disputes. In the leading BC case on this question, Quintette Coal Limited v. Nippon Steel Corp, Mr. Justice Gibbs described the courts’ role this way:

It is appropriate for the court to adopt, as a matter of policy, a standard which seeks to preserve the autonomy of the forum selected by the parties and to minimize judicial intervention when reviewing international commercial arbitration awards.

As we know however, NAFTA investor claims are not typical commercial disputes but routinely concern issues of broad public consequence - from water export controls and environmental standards to public postal services.

Nevertheless, one aspect of Mr. Justice Tysoe’s judgment is helpful because it overrules the Tribunal’s expansive reading of Article 1105. The judge also found that the Tribunal’s erroneous interpretation of Article 1105 tainted its criticism of the municipality’s failure to issue a construction permit to Metalclad. This effectively overturned the Tribunal’s ruling insofar as it concerned the actions of the municipality. It is important however, to recognize that the judge did not exonerate the actions of the local government or conclude that its actions were not expropriative.

This is clear from the judge’s decision to uphold the Tribunal’s findings that by creating an ecological preserve, the State government had expropriated the Company’s property. This is how the judge described the Tribunal’s view of NAFTA’s expropriation provision:

The Tribunal gave an extremely broad definition of expropriation for the purposes of Article 1110. In addition to the more conventional notion of expropriation involving a taking of property, the Tribunal held that expropriation under the NAFTA includes covert or incidental interference with the use of property which has the effect of depriving the owner, in whole or in significant part, of the use of reasonably to be expected economic benefit of property. This definition is sufficiently broad to include a legitimate rezoning by a municipality or other zoning authority. However the definition of expropriation is a question of law with which this Court is not entitled to interfere under the International Commercial Arbitration Act. [emphasis added]

The Tribunal’s view represents a stark contrast to the meaning of expropriation under Canadian law which has consistently refused to treat the exercise of municipal land-use authority as giving rise to such claims.

There are other aspects of this case that are relevant to municipal government, including the way in which the court addressed Mexico’s allegations of corruption and bribery against the company.

For present purposes however the Metalclad case is particularly important for two reasons. First, it demonstrates the enormous breadth of NAFTA’s expropriation rule. Second, it shows the wide latitude international arbitral tribunals will be allowed to interpret NAFTA investment disciplines as they see fit. As the law now stands, Canadian governments at all levels are vulnerable to such claims for taking measures that would never be considered acts of expropriation under Canadian law.

There are any number of ways in which NAFTA rules may be offended by the government measures affecting directly or indirectly the design, construction or operation of the Seymour water filtration plant. Thus, the failure to provide timely approvals, the imposition of public health or environmental orders, the early termination of a contract for alleged non-compliance or performance failure, or new regulatory standards might all be characterized as expropriation under the broad definition now accepted by the court.

The BC Supreme Court has clearly substantiated the validity of concerns that have been expressed about the impact of NAFTA investment rules but which the federal government remains reluctant even now to concede. In fact, only days after the release of Mr. Justice Tysoe’s ruling, the Prime Minister described NAFTA investment rules as working “pretty well.”

We also note that notwithstanding the Metalclad victory, some business groups have characterized the BC Supreme Court ruling as a defeat and have called upon governments to strengthen the investment disciplines in NAFTA. They have also insisted that similar requirements be maintained as a necessary elements of the FTAA initiative.

Finally, we note that the courts of other jurisdictions may adopt a different view of their authority to review NAFTA-based awards. These may be more interventionist than the approach adopted by Judge Tysoe, or less so. In each instance the judge will be guided, as was the BC Court by the domestic law of that jurisdiction.

Thus, the standard of judicial review of an arbitral award will depend upon the place of arbitration. Because BC was chosen in the Metalclad case, Mexico’s recourse was to a BC court. In a claim involving a BC municipality, the place of arbitration would inevitably be outside the province, if not the country. This raises the specter of the court of a foreign jurisdiction being the ultimate arbiter of whether the GVRD acted in breach of Canada’s obligations under NAFTA investment disciplines.