Joshua Satyagraha (5641675) International Law Governing Service and Investment

The Controversy of the Right to Expropriate by Government: the case study of Metalclad vs Mexico and Methanex vs United States of America

Introduction In the last two decades of the 20th century, great changes have taken place in policies and legal structures relating to foreign investment. The rapid changes in foreign investment have found their expression in numerous bilateral and multilateral investment treaties. The proliferation of such instruments has direct impacts on national sovereignty, federalism, and states ability to regulate in areas such as environmental protection and human health. In the past, foreign investment was largely regulated domestically. In general, the only international rules that applied to some aspects of foreign investment were rules of customary international law, and their application was purely exceptional. With the adoption of bilateral investment treaties beginning in the 1980s, an international legal framework started to emerge.1 Both developed and developing countries were eager to negotiate investment rules in order to further transnational investment. Because domestic laws and policies can be changed unilaterally, while bilateral and multilateral rights and obligations cannot, industrialized countries have preferred to rely on treaties as a more stable basis for their companies wishing to invest abroad. Developing and countries in transition on the other hand hope to attract foreign investment through the granting of extensive investor protection in treaties. They believe that the existence of an investment treaty will influence an investor in its choice whether or not to invest and that an increase in foreign investment will contribute to rapid economic development.2 Until now, more than 2000 bilateral investment treaties (BITs) have been concluded across the world. The number of investment treaties increased rapidly over the past 20 years, with a speeding pace in the past five years.3 It is a well recognized rule in international law that the property of aliens cannot be taken, whether for public purposes or not, without adequate compensation. Two decades ago, the disputes before the courts and the discussions in academic literature focused mainly on the standard of compensation and measuring of expropriated value. The divergent views of the developed and
1

Osterwalder, N. B. (2003). International Legal Framework on Foreign Investment. , pp. 2-3. Retrieved July 20, 2007, from http://www.ciel.org/Publications/Presentation_Kiev_Final%2021May03.pdf. 2 Ibid. 3 For a list of bilateral investment treaties and related information, see http://www.worldbank.org/icisid/treaties/intro.htm.

developing countries raised issues regarding the formation and evolution of customary law. Today, the more positive attitude of countries around the world toward foreign investment and the proliferation of bilateral treaties and other investment agreements requiring prompt, adequate and effective compensation for expropriation of foreign investments have largely deprived that debate of practical significance for foreign investors.4 A central provision of investment agreements is a prohibition on uncompensated expropriation or taking of investors assets. Early instruments dealing with foreign investment usually contained provisions regarding nationalization and/or expropriation. These terms were understood to cover direct expropriations of property by the host state through legislative or administrative measures, which resulted in a compulsory transfer of property rights. More recent investment treaties expanded the scope of expropriation to include indirect expropriation. 5 Indirect expropriation is also referred to as disguised or creeping expropriation and is the equivalent of a regulatory taking under U.S. law. In this context, the question arises whether an indirect expropriation also includes actions, which fall generally within the police powers of a state. International law and practice appear to exclude the normal exercise of sovereign regulatory powers from the obligation to compensate for expropriation. However, tribunals addressing this question have interpreted indirect expropriations to include regulations that aim to protect the environment and public health. 6 Expropriation Expropriation clauses have long been part of investment treaties between nations. These clauses guarantee foreign investors protection against seizure of their property by countries in which they invest. The goals of these clauses is to encourage investment in foreign countries by limiting the downside risk from potential expropriation of the investmenta very real concern in some countries. Initially these clauses covered only direct seizure of property, but over time their scope expanded to cover indirect expropriation, as well. Under indirect expropriation, a country uses some means, such as regulation or taxation, other than direct seizure to take away the value of an investors assets. The North American Free Trade Agreement (NAFTA) includes an especially broad provision on expropriation.7 Article 1110 provides that: No party may directly or indirectly nationalize or expropriate an investment of an investor of another Party in its territory or take a measure tantamount to nationalization or expropriation of such an Investment ("expropriation"), except: (a) For a public purpose;
4

Small, C. Y. (2004). OECD"INDIRECT EXPROPRIATION AND THE RIGHT TO REGULATE IN INTERNATIONAL INVESTMENT LAW, pp. 1. Retrieved July 18, 2007, from http://www.oecd.org/dataoecd/22/54/33776546.pdf. 5 Op. Cit Osterwalder, N. B. (2003).pp. 5. 6 Ibid. 7 Grab, D. (2004, December 10). Expropriation clauses: a natural extension of domestic takings law or much more?. The Department of Agricultural & Resource Economics , pp. 2-3. Retrieved July 19, 2007, from http://are.berkeley.edu/courses/EEP131/fall2006/NotableStudent04/RegulatoryTakingGrab.pdf.

(b) On a nondiscriminatory basis; (c) In accordance with due process of law and [National Treatment]; and (d) On payment of compensation This wording does not require that actual expropriation occur, merely actions tantamount to expropriation. Thus, environmental or social regulations could be considered tantamount to expropriation under this definition. Indeed, in several NAFTA cases, governments have been found liable for environmental regulations. Though NAFTA does not have the authority to prohibit governments from creating such regulations, it can force them to compensate the aggrieved party. This can give multinational corporations a great deal of leverage over foreign nations (Been and Beauvais 2003). In fact, investment treaties like NAFTA are one of the few, if not the only, mechanisms by which individuals and private corporations may sue and gain compensation from foreign, sovereign nations. The negotiations for the now-defunct Multilateral Agreement on Investment (MAI), and the current negotiations for the Free Trade Area of the Americas (FTAA) have both included expropriation clauses similar to the one in NAFTA (Geiger 2002, Wiltse 2003). Many environmentalists and advocates of national sovereignty fear that enacting such expropriation clauses will further harm countries abilities to enact legislation to protect the health of their citizens and ecosystems as they see fit.8 The following two cases provide an insight into the aspects that tribunals have in determining whether there has been an indirect expropriation of a private investment. Although not explicitly stated in the text of Article 1110 of NAFTA. Tribunals emphasize certain factors that create a presumption in favor of expropriation. Those factors include: (1) the effects of the government action, (2) reasonable reliance by the investor, (3) the degree of interference with a property right or the extent of the economic harm suffered, (4) the duration of the economic harm, and (5) the character of the government action. While none of the above factors is determinative, each plays a role in laying down a general framework for indirect expropriation determinations.9 Metalclad, a U.S. corporation, entered into an option-to-purchase agreement with COTERIN, a Mexican corporation, for the purpose of constructing a hazardous waste landfill on purchased land in the Mexican State of San Luis Potosi.10 COTERIN had previously received authorization from the Mexican federal government to construct and operate a transfer station for hazardous waste on the land. In September 1993, once COTERIN had been granted both federal and state permits, Metalclad exercised its option to purchase, on the understanding that only those permits were necessary for operation of the
8 9

Op. Cit Osterwalder, N. B. (2003).pp. 5. Edsall, R. D. (n.d.). INDIRECT EXPROPRIATION UNDER NAFTA AND DR-CAFTA: POTENTIAL INCONSISTENCIES IN THE TREATMENT OF STATE PUBLIC WELFARE REGULATIONS. Boston University School of Law BOSTON UNIVERSITY LAW REVIEW, Vol. 86:931, pp. 940. Retrieved July 18, 2007, from http://www.bu.edu/law/central/jd/organizations/journals/bulr/documents/EDSALL.pdf. 10 International Centre for Settlement of Investment Disputes, Case No. ARB (AF)/97/1 Metalclad Corporation vs United Mexico States, Par. 32-35.

landfill. Despite local resistance to the project, Metalclad began building in May 1994.11 Construction activities ground to a halt in October when the municipality ordered Metalclad to cease building for lack of a local construction permit. 12 Although federal officials assured Metalclad that it was federal not local officials who had the full authority to authorize construction, they suggested that Metalclad apply for a local construction permit to maintain good relations with the municipality.13 Metalclad then submitted an application for a local construction permit and began building the landfill.14 The municipality denied Metalclads application in December 1995 after construction had already been completed. 15 Additionally, the municipality filed an administrative complaint and a preliminary injunction against operation of the landfill. From May through December 1996, Metalclad and the municipality endeavored to come to an agreement, but could not. In a final effort to keep the landfill from functioning, the Governor of San Luis Potosi issued an Ecological Decree in September 1997, declaring the area encompassing the landfill a Natural Area for the protection of rare cactus, and permanently precluding its use as a landfill.16 On the basis of the municipal governments actions, Metalclad filed a claim under Chapter 11 of NAFTA alleging, inter alia, that the governments interference with operation of the landfill constituted a measure tantamount to expropriation.17 According to the tribunal, expropriation under NAFTA includes not only open, deliberate and acknowledged takings of property, such as outright seizure or formal or obligatory transfer of title in favor of the host State, but also 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 or reasonably-to-be-expected economic benefit of property even if not necessarily to the obvious benefit of the host State.18 By permitting or tolerating the conduct of Guadalcazar in relation to Metalclad which the Tribunal has already held amounts to unfair and inequitable treatment breaching Article 1105 and by thus participating or acquiescing in the denial to Metalclad of the right to operate the landfill, notwithstanding the fact that the project was fully approved and endorsed by the federal government, Mexico must be held to have taken a measure tantamount to expropriation in violation of NAFTA Article 1110(1).19 The arbitrators also cited the investors reasonable reliance on representations by the federal government as further evidence of expropriation. While the tribunal conceded that the municipalitys reasons for
11
12

Ibid. Metalclad, Par. 37-38. Ibid. Metalclad, Par. 40. 13 Ibid. Metalclad, Par. 41. 14 Ibid. Metalclad, Par.42. 15 Ibid. Metalclad, Par. 50. 16 Ibid. Metalclad, Par. 59. 17 Ibid. Metalclad, Par.72. 18 Ibid. Metalclad, Par 103. 19 Ibid. Metalclad, Par 104.

denying the local construction permit were, in part, environmental, it found as a matter of law that the Mexican federal government had exclusive authority to permit hazardous waste landfills, and that the municipal government had therefore acted outside the scope of its authority. These measures, taken together with the representations of the Mexican federal government, on which Metalclad relied, and the absence of a timely, orderly or substantive basis for the denial by the Municipality of the local construction permit, amount to an indirect expropriation.20 The Methanex case is an investment dispute between Canadian-based Methanex Corporation and the United States, arising from the provisions in the North American Free Trade Agreement's (NAFTA) Chapter 11 on investment. Methanex is a major producer of methanol, a key component of MTBE (methyl tertiary butyl ether), which is used to increase oxygen content and act as an octane enhancer in unleaded gasoline. Methanex launched its international arbitration against the United States in response to the March 1999 order by the State of California to ban the use of MTBE by the end of 2002.21 California argued that banning MTBE was necessary because the additive is contaminating drinking water supplies, and is therefore posing a significant risk to human health and safety, and the environment. Methanex argued in its original submission that the ineffective regulation and non-enforcement of domestic environmental laws, including the U.S. Clean Water Act, is responsible for the presence of MTBE in California water supplies. The company argued that the ban is tantamount to an expropriation of the companys investment and thus a violation of NAFTA's Article 1110; was enacted in breach of the national treatment obligation in Article 1102 of NAFTA; and was also in breach of the minimum international standards of treatment obligations in Article 1105 of NAFTA. It was seeking almost $1 billion in compensation from the United States.22 The ruling on Article 1110 of NAFTA, on expropriation, is potentially the most significant part of this decision. From a public interest perspective it is also very welcome, caveats adduced by the Tribunal notwithstanding. Methanex claimed that the regulatory ban on MTBE amounted to a measure tantamount to expropriation in breach of Article 1110 of NAFTA. The economic impact of the measure on Methanex amounted to a taking that required compensation. Methanex relied in large part on the approach to expropriation in the Metalclad v. Mexico decision under Chapter 11, which highlighted the economic impact of a regulatory measure as the key factor for analysis under Article 1110.23

20 21

Ibid. Metalclad, Par 107. Mann, H. (2005). The Final Decision in Methanex v. United States: Some New Wine in Some New Bottles. IISD (International Institute for Sustainable Development), pp. 4. Retrieved July 20, 2007, from http://www.iisd.org/pdf/2005/commentary_methanex.pdf 22 Ibid. 23 Ibid. pp. 6

The Methanex Tribunal rejected this approach. In its place, it took an approach much more akin to a classic police powers24 approach under international law. The Tribunal made notes which clarifies carefully the type of measure that this is not a direct expropriation or a creeping expropriation, and that there was no transfer of title or other transfer of assets from Methanex to the US or anyone else. Thus, this measure fell into the category of a measure tantamount to expropriation. The Tribunal then stated that: But as a matter of general international law, a non-discriminatory regulation for public purpose, which is enacted in accordance with due process and, which affects, inter alia, a foreign investor or investment is not deemed expropriatory and compensatory (then follows a caveat to be considered in a moment).25 The same reasoning is then found a few paragraphs later where the Tribunal states that From the standpoint of international law, the California ban was a lawful regulation and not an expropriation.26 At the end, the Tribunal has made a detailed differentiation in how to characterize the measures that are for a public purpose, non-discriminatory and enacted in accordance with due process are not, expropriations. Not considered as expropriations or measures tantamount to expropriation are not subject to compensation. However, the tribunal emphasized that, as a principle of general international law, a non-discriminatory regulation for a public purpose, which is enacted in accordance with due process . . . is not deemed expropriatory and compensable unless specific commitments had been given by the regulating government to the then putative foreign investor contemplating investment that the government would refrain from such regulation.27 The outcome of this case might be different if a specific agreement (discussing if such event occurs, specific compensation will be given) was arranged between the State of California and Methanex before the case happened. Differ from the Methanex case, the tribunal in Metalclad determined that the government acts constituted measures tantamount to expropriation under Article 1110. In that case, the investor had already purchased land for landfill site, relying on the representations by the federal government that all the required permits had been filed and that the local permit would be required by the federal authorities. The decision there turned on both the significant economic impact on the private investor and the reasonable reliance of the investor on representations made by the Mexican government.

24

Police power is an old international law term for what we would now call regulatory measures by a state to protect or enhance the public welfare. The full scope of police powers has, arguably, never been firmly established in international law. Op.Cit. Mann, H. pp. 6 25 Final Award, Part IV, Chapter D, para 7. 26 Ibid. Para 15. 27 Op. Cit. Edsall pp. 19

The main difference in the case of Metalclad and Methanex is that the investor in Metalclad relied substantially on the Mexican governments promises with regard to federal, state, and local permits. Furthermore, the municipality agreed to some stage to Metalclads land fill construction, since they waited over a year to deny the permit and never once attempted to disrupt the building process. Therefore the problem was in the (political) inconsistency of the Mexican government in giving permit to its investor, which resulted a costly administrative to the Mexican government. However, Methanex did not rely on explicit governmental statements that the gasoline additive industry would not be regulated. Methanex should have known that such an industry will be subject to environmental regulation(s). Therefore there was no national treatment infringement in this case, because the ban regulation enacted by the state of California was destined to protect the public as stated in the exception to expropriate article 1110 (a) NAFTA agreement which is public purpose. Thus, methanol banning by the state of California is also apply to domestic enterprise in California with the same industry, for that reason the state of California did not discriminate. To summing up, Article 1110 of NAFTA disallows not only physical takings of private property, but also indirect takings and measure[s] tantamount to expropriation. Resolving disputes arising under this and other provisions of Chapter 11, Articles 1116 and 1117 set up a process by which private investors of one party may bring an arbitration legal action against another party to the treaty. The expropriation clause has still created argument in International investment law, where the inconsistency could lead to problems for both investor and host countries. Investor nations are wish to have clear standards in the interests of their private investors, so that investors can be sure the host country will treat their foreign investors the same as treating their domestic investors. Private investors who fear that the host nation will attempt to gradually nationalize their property will be less likely to invest. Equally, host nations have an interest in set up clear treaty guidelines so that they can avoid needless legal action from private investors. This two edge blade investment mechanism can hurt and create dilemma for both parties. Concerning the foreign investor side, their business is just a regulation away from making an exit from the host country uncompensated. For the hosting country, an inflexible style of regulating law can make them a less attractive nation to invest with.