Balancing Act
Fifteen years of NAFTA arbitration have eased its critics' worst fears. But the dispute resolution system remains a work in progress.
The American Lawyer
By Michael D. Goldhaber
August 01, 2009
When H. Ross Perot warned that the North American Free Trade Agreement (NAFTA) would cause a giant sucking sound, he didn't envision dollars being vacuumed up by U.S. and Canadian law firms. But 15 years after NAFTA came into force, one of its chief effects has been to create a booming practice in investment arbitration and advice. The NAFTA agreement on investment disputes--confusingly known as Chapter 11--gives foreign investors the
right to sue nations for unfair treatment or seizure of their investment before panels of private arbitrators. But NAFTA has clearly not triggered a siphoning of U.S. taxpayer dollars to Mexico or Canada. Only American investors have ever won damages under NAFTA Chapter 11, and they haven't won big. The real significance of NAFTA arbitration lies in its role as a trendsetter for high-stakes investment arbitration around the world.
To date, NAFTA has only generated two dozen mature investor-state disputes [see "The Ties That Bind," page 51]. In terms of wins and losses, the U.S. government leads the league tables with an undefeated 8-0 record, followed by Mexico at 8-4, and Canada at 1-3 (scoring the lone settlement as a loss). U.S. investors boast a respectable record of 7-8, compared with a cheerless 0-9 for Canadian investors. Mexican investors have so far sat on the sidelines.
In terms of dollars recovered, 15 years of NAFTA only equate to one respectable week in Madison County, Illinois. Todd Weiler, a Canadian attorney who operates the leading Web site for NAFTA case research, naftaclaims.com, calculates that investors have so far recovered only about two cents on the dollar, or $71 million before interest on claims of $3.8 billion. This damages calculation excludes a pair of yet-to-be-quantified awards against Mexico, and well over $1 billion in active pending claims.
But these modest caseload and recovery numbers understate NAFTA's importance for legal business. "NAFTA is the be-all-and-end-all for our international trade group," says partner Simon Potter of Canada's McCarthy Tétrault. He estimates that 20 percent of his group's work relates to NAFTA dispute resolution--even if that work only involves threatening a NAFTA claim on behalf of an American client to influence Canadian legislative or regulatory debates. Virtually all of Canada's top-tier firms are players in the field, as well as leading mid-tier firms such as Borden Ladner Gervais, Lang Michener, and Heenan Blaikie. NAFTA has also spurred the development of investment arbitration at large, which is an engine of growth for major law firms worldwide.
The numbers also understate NAFTA's role as a legal bellwether. It is the best known of more than 2,600 treaties around the world that give foreign investors the right to sue states. As a result, NAFTA has stood at the center of several controversies--particularly over arbitral secrecy, and the perceived surrender of national sovereignty over regulation to international lawyers. The NAFTA system has gone far to address these two concerns. But other design flaws of investment arbitration--the lack of judicial independence and of appeal on the merits--have only been underlined by the NAFTA experience.
NAFTA arbitration entered the American political debate in August 2000, when the first claim to be filed and fully litigated resulted in a pro-business judgment. In Metalclad Corp. v. Mexico, a Mexican governor with no environmental authority had abruptly overrode federal promises to let an American investor operate a toxic waste dump, mounted a public campaign against the dump, and declared the area a rare-cactus preserve. The arbitrators ordered Mexico to pay $17 million to compensate the investor.
To its critics on the left, Metalclad raised the specter of business using NAFTA as a sort of global takings clause, undercutting considered regulation by democratic states. In a cryptic opinion, the panel defined expropriation to include "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." That definition covers a lot of ground. The Canadian judge who reviewed a challenge to the Metalclad award, while recognizing that he had no power to touch this aspect of the case, worried that even "a legitimate rezoning" might violate NAFTA.
While some isolated language in the Metalclad opinion may be unduly sweeping, most students of arbitration believe that the panel reached the right result. On a fair reading of the facts, Metalclad sounds less like thwarting green do-gooders and more like reining in arbitrary politicians, which was one of NAFTA's aims.
"To give up your sovereignty to do silly things is good," says McCarthy Tétrault's Potter.
Maybe so. But NAFTA-related fears--mostly on the left--reached a crescendo when arbitrators asserted jurisdiction in 2001-02 over a pair of huge Canadian cases against the United States: a $970 million claim from Methanex Corporation and a $725 million claim from The Loewen Group, Inc. Methanex, which manufactures methanol fuel, struck a nerve because it had the chutzpah to challenge the ban of a dangerous fuel additive in the heart of environmentalism--California. Senator John Kerry, who was angling for the Democratic presidential nomination, introduced a bill (never passed) that would subject NAFTA takings claims to narrower U.S. constitutional standards.
In retrospect, though, this was the high-water mark of the anti-NAFTA movement. For as it unfolded, Methanex took the sting out of Metalclad .
The secrecy of arbitration was easy for antiglobalization activists to paint as sinister—and equally easy to roll back. Undue privacy was a vestige of the private arbitral system that has been adapted by investors for public use. In the year after the Metalclad judgment, the U.S., Canada, and Mexico undertook to publish all NAFTA filings and opinions, and the Methanex panel held that it had the power to accept amicus briefs from interested nonprofits. Posting documents online had a rapid impact, according to Barton Legum of Salans, who served as the U.S. Department of State's first NAFTA arbitration chief. "In a very short time," he says, "there was a sea change in the attitude of the legal community toward confidentiality in investment treaty arbitration." In summer 2004 the Methanex arbitrators further defanged their critics by opening their hearings to the public. Without the aura of concealment, arbitration became boring: Journalists didn't bother to attend the hearings. The final opinion in the case had the lengthy reasoning style of U.S. common law, which is another important aspect of transparency.
When put to the test, NAFTA arbitrators had no trouble distinguishing between a legitimate and a bogus environmental regulation. California's fuel additive ban did not require compensation. The Methanex claim was rejected--and with it the critics' greatest fear, that NAFTA would hand the levers of government to multinational corporations. The panel clarified that a state may totally destroy a business without compensation when it is "motivated by [an] honest belief, held in good faith and on reasonable scientific grounds," and as long as it regulates with due process, without discrimination, and without violating specific commitments to investors. Such an approach is more consistent with domestic U.S. practice.
But if Methanex allayed old concerns about NAFTA, the Loewen result raised new ones. In the underlying case, a Mississippi jury had imposed a ruinous award of half a billion dollars on Loewen, a Canadian funeral home chain, based on a token claim of less than $10 million. Loewen had settled for $175 million rather than post a $625 million appeal bond and file a long-shot petition for cert that seemed to be doomed by jurisdictional precedent. The arbitrators accepted Loewen's view of the case--agreeing that it had suffered a "disgraceful" denial of justice--but declined to rule in the company's favor because they dubiously concluded that Loewen had not exhausted its remedies. The arbitrators frankly noted that undue intervention by international panels could imperil NAFTA's "viability."
Loewen was widely panned in the arbitration community as a mistake and an accommodation of anti–NAFTA sentiment in Congress ["A 'Completely Appalling' Decision," Focus Europe , Summer 2004]. " Loewen was just a travesty," says Potter. "I think there's a very broad consensus on that." Another leading figure in investment arbitration comments: "I think the outcome would have been very different if the U.S. had not been the respondent in that case. [But] if Loewen had won, we might not have a Chapter 11 today, and maybe that's why the tribunal decided the way it did."
If there was an error in Loewen , it went uncorrected because arbitration lacks review on the merits. That omission argues for the creation of an appeal mechanism to ensure legal uniformity and accuracy.
Less obviously, Loewen is also an argument for independent judges. NAFTA arbitrators are practitioners, academics, or retired judges selected by the parties or, failing that, by the secretary-general of the World Bank's International Centre for Settlement of Investment Disputes. The core complaint by a leading academic critic of investment arbitration, Gus Van Harten of Osgoode Hall Law School in Ontario, is that private arbitrators have a vested stake in the system. Van Harten reasons that there is generally a structural incentive for arbitrators to favor investors, because they depend on the proliferation of treaty claims by investors for future appointments. But arguably, in the special case of Loewen--where a pro-investor award could have killed the golden goose by provoking a political backlash--the arbitrators' self-interest was to rule for the state.
The mere existence of such suspicions tends to delegitimate the system. For even if one trusts in arbitral integrity, independent judges are needed to avoid the appearance of conflict.
But Sidley Austin's Daniel Price, who helped to draft the investment chapter as a young government attorney and has frequently fended off its critics, says that the question whether Loewen was decided incorrectly has no systemic implications.
"I don't think it's appropriate to judge the success of NAFTA's dispute resolution mechanism on any single case," he says. "On any given day in any given country, one will find wrong judgments. You have to look at the body of jurisprudence as a whole and ask yourself, 'Does the existence of NAFTA tribunals contribute to the prosperity and integration of the hemisphere?' You've got to say yes."
At bottom, Price is arguing that robust investor protection is justified to promote economic growth. The link between the rise of arbitration and investment flows is an empirical question, and the sizable literature on point is collected in a new book, The Effect of Treaties on Foreign Direct Investment (Oxford University Press). The debate remains wide open--but it is fair to say that more studies tend to confirm the link than not.
Accepting that investor protection is a worthy enterprise only makes it more urgent to improve its institutional design. Even if one rejects the most jaded criticisms of Loewen , the fact that they persist shows the need for independent judges to dispel the appearance of self-dealing, and for an appeals court to correct errors. Methanex moved investor arbitration toward a more judicial model. That journey will inevitably continue.
