Investment arbitration under NAFTA chapter 11: a threat to sovereignty of member states?

• Author: Owens, William L.

ABSTRACT: Critics of NAFTA Chapter 11's investor state dispute settlement mechanism are primarily concerned with its invocation by corporate entities and its potential to effectively overturn or significantly weaken NAFTA states' ability to legislate or regulate in the public interest. This article will address this central concern and demonstrate, by evaluating Chapter 11 arbitration results, that these criticisms have been over-stated. While developing nations like Mexico are undoubtedly conflicted in their willingness to accept 1SDS agreements, participation by all three NAFTA countries in this mechanism can lessen the political risk for foreign investment and attract much-needed outside capital in order to spur economic activity.

Introduction

Cross-border investment liberalization is a central goal of the twenty-year-old North American Free Trade Agreement (NAFTA). (1) In pursuit of this goal, NAFTA includes a number of provisions designed to protect foreign investors from discrimination by host states and to facilitate the settlement of international investment disputes. These investment provisions include some of NAFTA's most contentious features, the investor protection standards and investor-state dispute settlement (ISDS) mechanism found in Chapter 11 of the agreement. (2) The proposed inclusion of similar provisions in new, multilateral trade agreements including the Trans-Pacific Partnership (TPP), the Canada-EU Trade Agreement (CETA), and the Trans-Atlantic Trade and Investment Partnership (T-TIP), makes an analysis of the impact of these provisions timely. By assessing the performance of NAFTA investor-state arbitration tribunals to date, this article will demonstrate that though weaknesses deserving of reform exist, Chapter 11's ISDS mechanism is a necessary tool of investor protection and has not eroded the power of sovereign states to regulate in the public interest.

NAFTA's Chapter 11 aims to create a fair and predictable framework to allow for expanded flows of cross-border investment, which in turn can generate greater economic growth across North America. (3) Improving the efficiency of capital allocation is meant to enable each signatory nation to benefit from the corresponding growth in cross-border investment associated with freer trade in goods and services. (4) "Since NAFTA came into force in 1994, foreign direct investment in North America has risen from $110 billion per year in 1992 to $650 billion per year in 2010, a 490% increase." (5)

In basic terms, Chapter 11 outlines investor protection principles based on international reciprocity and equitable treatment, and sets up an arbitration process to address the breach of these obligations by a signatory country. (6) This dispute settlement mechanism provides foreign investors with the authority to proceed directly against a NAFTA government (7), a standing that represents a meaningful departure from past practice when such disputes were traditionally handled between national governments. (8) By empowering an investor to directly challenge a NAFTA government, the investor's grievances are theoretically less politicized, and adjudicated more impartially than they would be through state-to-state negotiation. (9)

Critics of Chapter 11 are primarily concerned with the use of this power by corporate entities and its potential to effectively overturn or significantly weaken NAFTA states' ability to legislate or regulate in the public interest, according to their respective constitutional powers and responsibilities. In other words, though the narrow interests of investors may be adversely affected by member states' public policies, these private interests should not be able to trump public regulation for environmental protection, consumer safety, and other legitimate sovereign state actions. (10) This potential investor influence goes well beyond that contained in the World Trade Organization's (WTO) regime, which does not accord any substantive rights to private parties, whether corporations, NGOs, or other non-state actors. This article will address this central concern and demonstrate, by evaluating Chapter 11 arbitration results, that these criticisms have been over-stated. Rather, Chapter 11 does not employ an entirely new ISDS mechanism, its decisions have not resulted in critics' feared outcomes of investors overturning public regulations, and it contains a number of exemptions and safeguards that can prevent its abuse in the future.

1. The U.S. History with ISDS, and Some Notable Features of Chapter 11

The U.S. is not new to ISDS. In fact, the United States has a long history of involvement in international investment arbitration, dating as far back as the Jay Treaty of 1794, which allowed British investors access to international arbitration in awarding compensation for losses they sustained in the United States during the Revolutionary War. (11) More recently, since 1982, the United States has entered into fifty bilateral investment treaties that are currently in force and include ISDS provisions." During this time, although the United States has been sued 17 times under Chapter 11 and other such investment agreements, it has never lost a case. Therefore, the United States has yet to encounter a situation in which a domestic regulation came under threat by the ruling of an investment arbitration panel. (12)

Commentators may argue that the U.S. is imposing a double-standard on developing nations as its leverage repels challenges to domestic regulations while well-resourced, U.S. multinational firms are able to extract gains from less powerful developing nations. (14) If this is indeed the case, the author of this article was not able to identify a body of supportive evidence demonstrating such a trend. Within NAFTA, Mexico decided it was in its national interest to accept ISDS provisions. While developing nations like Mexico are undoubtedly conflicted in their willingness to accept ISDS agreements, participation can lessen the political risk for foreign investment, attracting much-needed outside capital in order to spur economic activity. (15) Interestingly, the body of evidence present in NAFTA's Chapter 11 cases does not point to a rich-poor country divide. Most claims have been made between the United States and Canada rather than between the U.S. and Mexico, or between Canada and Mexico. In fact, Canada has faced the greatest number of Chapter 11 claims. (16)

To date, there have only been 68 Chapter 11 cases in NAFTA's 20 years of existence, amounting to just over four per year on average; the vast majority of these cases have either favored the national government or have not reached a settlement or resolution.

As shown above, there is no discernible upward trend in the volume of claims made over time, nor does the record demonstrate a greater quantity or scope of decisions reached. Simply put, nothing approaching the worst-case scenarios articulated by ISDS critics of proliferating corporate suits, or harmful anti-sovereignty, anti-democratic or anti-public interest decisions, have occurred.

In examining the outcomes of each of these cases in order to assess the overall impact of Chapter 11, it is important to keep several points in mind. First, a distinction should be made between the arguments of claimants and the actual findings of arbitration tribunals. Though some investors under Chapter 11 have made bold, broad claims, the actual findings of the tribunals have been much narrower in scope. In total, while approximately $55 billion in damages have been sought by Chapter 11 claims, only $430.4 million in damages sought have been awarded and paid to foreign investors. (18) Of all eighty-six claims that have been filed under the NAFTA to date, 21 cases (24.4%) were dismissed or won by governments, 14 cases (16.2%) were won by investors or resulted in settlements in favor of investors, and the remaining cases (59.3%) are pending or have yet to be concluded. (19)

For example, although much has been made recently of US-based Eli Lilly's $500 million claim (20) against the Canadian government over the invalidation of Lilly's drug patents, no arbitration decision has been issued. In essence, Lilly claims that the invalidation is tantamount to expropriation, among other violated protections under Chapter 11...