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Conflict of Laws

Project

Investor State Dispute


Settlement under NAFTA
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
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

was considerably strengthened in the Uruguay Round. Gifford (1997) and Brosch (1998)
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
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.org
4 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

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
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

5 Id. art. 1102.


6 Id. art. 1103.
7 Id. art. 1104.
8 NAFTA Article 1121.
9 NAFTA Artides 1116 and 1117.

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
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.

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 InterAmerican 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.arts1.1 02, 1103.
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),

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
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

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.

16 Id. art. 1122.

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
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.
17 NAFTA art. 1121.
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.

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
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 Inter22 Id. art. 1126(2).
23 Id.art. 1127.
24 Id. art 1128.
25 Id.art. 1132.
26 Id.art. 1134.

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
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
27 Id. art. 1136.

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.