A brave new Lochner era? The constitutionality of NAFTA Chapter 11.

• Author: Louthan, Steve
• Position: Breach of state immunity through international arbitration

ABSTRACT

In the eight years since its adoption, NAFTA Chapter 11 has escaped significant scrutiny from academics and journalists alike. However, with the recent filing of several Chapter 11 expropriation claims involving U.S. states, Chapter 11 has begun to gain some notoriety in the press and sparked at least two legal symposia this past year.

This Note begins by highlighting the recent Methanex Chapter 11 claim involving the State of California. Methanex, a Canadian chemical manufacturer and importer, claimed $1.6 billion in damages over California's ban of the chemical MTBE. Despite the EPA's classification of MTBE as a possible carcinogen and an academic study that documented its presence in over ten thousand groundwater sites, Methanex claimed that California's ban "expropriated" their investment. Methanex argued it is due just and timely compensation for this purported expropriation. Moreover, Chapter 11 disputes, by and large, remain closed to public scrutiny because of the rules of international investment arbitration.

It is not surprising that such claims sparked a modest debate over the policy implications of Chapter 11 and its dispute resolution procedures. Though several critics note that many Chapter 11 claims push the limits of credulity and that adjudication of these claims needs to occur in for a to which the public has access, the threshold question of whether NAFTA Chapter 11 is constitutional remains ignored. This Note argues that Chapter 11 raises serious constitutional questions concerning the Eleventh Amendment and Article III. With the Supreme Court's renewed emphasis on federalism, it is far from clear whether NAFTA Chapter 11 is constitutional.

At the outset, a word of caution is due to the reader. This Note makes an important substance-over-form assumption by assuming that the Eleventh Amendment is implicated. Arguably, the Eleventh Amendment is never reached because the United States, as signatory party of NAFTA, stands in as a proxy for any U.S. state mired in a Chapter 11 dispute. If a judgment is won involving a U.S. state, the judgment is formally won against the United States. Though the United States will then sue the state for the repayment of any judgment, arguably the Eleventh Amendment is never reached because the state is never party to the original suit. Though such reasoning is provocative in its own right, this Note assumes the Eleventh Amendment is reached because the substance of such a suit is a proceeding against the state qua state.

1. INTRODUCTION

   In his opening statement before the Senate Committee on Environment and Public Works, Senator Howard Metzenbaum called the factory and living conditions in Mexico "truly unbelievable." (1) Metzenbaum then reeled off a litany of horribles, arguing that if NAFTA permits American corporations to increase their profits by standing on the backs of the Mexican poor and exploiting Mexico's non-existent environmental enforcement it would be nothing short of immoral. (2) Billionaire Ross Perot echoed a far more practical concern during the second and third debates of the 1992 Presidential election. (3) In perhaps the most notable quote of the entire campaign, Perot warned that, if NAFTA passed, there would be "a giant sucking sound of jobs being pulled out of this country." (4)

   Both Metzenbaum's ideals and Perot's folksy prudence summarize the two popular arguments attacking NAFTA during its passage through Congress. (5) However, both arguments ignore the import of NAFTA Chapter 11 and what might be the most significant evisceration of state police power since the Supreme Court freed the states from Lochner's shackles in 1937. (6) Labeled by several as an "obscure clause," (7) NAFTA Chapter 11 hamstrings traditional state police power actions by providing foreign investors with a secret forum where significant monetary relief can be sought under a theory that state action indirectly "expropriated" their investment. (8)

   Under Chapter 11, a domestic corporation of any NAFTA country can challenge any government action of the other participating states under the broad and vaguely defined rubric of "expropriation." (9) Methanex, a Canadian producer of methyl tertiary butyl ether (MTBE), recently utilized this mechanism to challenge California's regulatory ban of MTBE. On March 25, 1999, California Governor Gray Davis issued an executive order banning the use of MTBE for gasoline. (10) MTBE had long been placed on the EPA's list of possible carcinogens and, according to a University of California-Davis study, it was found in over ten thousand groundwater sites. (11) Within three months, Methanex, a Canadian Producer of MTBE, submitted a Notice of Intent to the United States NAFTA office claiming that California "expropriated" its investment in violation of Chapter 11. (12)

   Methanex requested damages of approximately $1.6 billion. Utilizing Chapter 11's dispute resolution mechanism, Methanex forced California's action to be reviewed by an international arbitration panel rather than an Article III or state court. (13) Because the stakes are high for California, international arbitration unpredictable, and international law on indirect takings remains unsettled, there is strong incentive to settle Methanex's claims even though California's actions would easily pass federal and state scrutiny. (14) Defensive settlement in the face of high stakes has been the fate of at least one similar Chapter 11 suit. (15)

   Chapter 11 also affords the investor perhaps the most coveted of protections for challenging a public regulation: complete secrecy. (16) Proceedings under the rules of international arbitration are kept secret; Chapter 11 incorporates these rules. (17) In short, an alleged expropriation caused by a public regulation, the drafting and passage of which were public, is decided in a secret proceeding. The public cannot access evidence, arguments, or the ultimate rationale for the judgment. (18)

   In asking the question "What in Capitalism cannot be Co-opted?" the Frankfort School's Herbert Marcuse noted the conflict between wealth-maximizing schemes like Chapter 11 and arguably inefficient governmental or constitutional structures such as the doctrines of federalism and separation of powers. (19) For those like Marcuse, who are critical of the weight given to market values, the Methanex dispute is a textbook example of how capitalism tacitly extorts concessions of public control in order to increase efficiency and profitability. (20)

   For those wary of phrases like "triumph of capital," Chapter 11 fails on an altogether different ground because of its disregard for federalism's siae qua non of local control. In the proliferating global economy, the growing popularity of Chapter 11 expropriation claims could eventually hamper both state and local decision-making. Liability for significant economic damages and fear of acquiring an "anti-investment" image are two specters that haunt states. (21) Though perhaps not having the initial emotional appeal of the image that NAFTA allows American corporations to increase their profits by stepping on the Mexican poor, the harm that Chapter 11 poses to state and local sovereignty could have more far reaching and long-term effects.

   This Note examines the constitutionality of NAFTA Chapter 11. Part II attempts to explain the lack of consideration given to Chapter 11 by academics, journalists, and Congress. Chapter 11's general framework will then be laid out. Part III addresses in detail the significant Eleventh Amendment and Article III problems that Chapter 11 presents by analyzing Chapter 11 as if it operates in a domestic rather than international context. In other words, if Congress created an interstate arbitration tribunal for takings claims made by residents of one state against another state, what would be the result? Part IV then examines whether the federal government's foreign affairs powers, invoked because of NAFTA's international character, absolve Chapter 11 of its constitutional failings. This Note finds such absolution doubtful.

   This analysis of Chapter 11's constitutionality involves three of the most nebulous and difficult areas of the Supreme Court's jurisprudence: the scope of the treaty power, the Eleventh Amendment, and Article III courts. This Note relies primarily on the Supreme Court's own language while attempting to integrate the vast corpus of secondary literature on these three difficult and dense areas. Though attempting to be comprehensive, these areas of jurisprudence are so nuanced that a thorough scholarly treatment would require many more pages.

2. CHAPTER 11: NOT SIMPLY ANOTHER BILATERAL INVESTMENT TREATY

   Intuitively, it is troubling that a foreign investor can arguably extort settlement from the State of California over a simple health and safety regulatory action. Though Chapter 11 has been gaining some attention in the past year, in general it has received little scholarly attention over the first six years of its existence, other than a few criticisms by a handful of environmentalists. (22) Hence it is initially worth asking why Chapter 11 has largely been ignored. Examining the context in which Congress passed Chapter 11 reveals several reasons why it has not drawn much attention from mainstream media, academics, or politicians.

   A brief perusal of Chapter 11 would lull the reader into believing that it is yet another ordinary bilateral investment treaty (BIT). BITs provide the necessary legal rules and incentives for protecting and securing direct foreign investment. (23) In fact, for some capital-exporting states, a BIT is a prerequisite for acquiring investment insurance by the foreign investor. (24) By 1994, over 700 BITs had been concluded. (25) On the surface, Chapter 11's structure and language mirrors other BITs. (26)

   Perhaps more important than this belief that Chapter 11 is just another BIT is that Chapter 11 already existed in NAFTA's...