Article: December 2018: International Arbitration Update

USMCA – What Next for ISDS? The agreed draft of the new NAFTA agreement between the U.S., Mexico and Canada, called the United States – Mexico – Canada Agreement (the “USMCA”), contains a number of fundamental changes to the NAFTA regime. One of those changes is to the investor-state dispute settlement (“ISDS”) regime.

What is ISDS?
ISDS is a mechanism included in many trade and investment treaties (including NAFTA) that provides foreign investors with a means of resolving disputes with host states. The basis for this is consent – under such treaty
provisions sovereign states consent to being held liable directly to investors for violation of treaty obligations.
Typically, the method of dispute resolution has been binding international arbitration.

Chapter 11 of NAFTA sets out the treaty’s ISDS provisions. It allows investors from NAFTA states (ie, the U.S., Canada and Mexico) that have made investments in another NAFTA state to bring arbitration against the host state for violation of its treaty obligations. Treaty obligations under NAFTA include (amongst other things): (i) the prohibition against expropriation (including indirect expropriation) except where certain criteria are met, and
the obligation to pay fair compensation for any permissible expropriation; (ii) the obligation to accord foreign NAFTA investors no less favorable treatment than accorded to the host state’s own investors (“national treatment”); (iii) the obligation to accord foreign NAFTA investors no less favorable treatment than accorded to investors of any other state (“most-favored nation treatment” or “MFN treatment”); and (iv) the obligation to accord foreign NAFTA investors the minimum standard of treatment as required under international law, including “fair and equitable treatment” and “full protection and security”. Historically, “fair and equitable treatment” has addressed a number of separate aspects, including the protection of foreign investors’ legitimate expectations (See, e.g. Tecmed v Mexico, ICSID Case No. ARB(AF)/00/2, Award, May 29, 2003).

ISDS Under the USMCA
The current, agreed text of the USMCA changes fundamentally the ISDS scheme going forward. Claims based on investments made during the lifetime of NAFTA will not be affected, although they have to be brought within three years of NAFTA’s termination.

The USMCA’s ISDS provisions (Chapter 14) only allow for investor-state arbitration to be brought by: i) U.S. investors against Mexico; and ii) Mexican investors against the U.S. In other words, investors may no longer bring claims against Canada, and Canadian investors will no longer be able to bring claims against either the U.S. or Mexico. Parties seeking to arbitrate such claims will have to look for alternative grounds of jurisdiction, such as arbitration clauses in the investment contracts themselves or other treaties with ISDS provisions. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership to which Canada and Mexico are parties, contain ISDS provisions, and once it enters into force it is likely that Mexico-Canada investment claims can be brought under it.

Unlike NAFTA, the USMCA now draws a distinction between claims based on “covered government contracts” and all other types of investment claims. “Covered government contracts” are defined as contracts with national authorities in the host state in the following sectors: oil and gas; power generation; telecommunications; transportation services; and infrastructure (Section 6, Annex 14-E). As will be seen, where covered government contracts are involved, the degree of protection accorded by the USMCA’s ISDS mechanism is stronger.

Under the USMCA’s ISDS provisions, substantive claims that may be brought are limited. They must relate to the following: direct expropriation; national treatment; and MFN treatment (Art 3.1, Annex 14-D). The exception is in the case of covered government contracts; in such cases, claims may also be brought based on indirect expropriation and the international minimum standard of treatment.

Procedurally, except where covered government contracts are concerned, investors seeking to bring an ISDS claim must first file suit and attempt to obtain relief in national courts of the host state before making use of the ISDS mechanism. Article 5 of Annex 14-D provides that disputes may proceed to arbitration only after 30 months have elapsed from the initiation of proceedings in national courts, or after a final national court decision has been rendered. There is an apparent inconsistency with Appendix 3, which provides that U.S. investors may not submit to arbitration claims against Mexico if that claim has been brought before the Mexican courts. It remains to be seen how these provisions will be reconciled.

Finally, the USMCA has sought to clarify the meaning of the various state obligations. Importantly, it has rejected explicitly the “legitimate expectations” understanding of fair and equitable treatment – Article 14.6(4) provides
that breach of an investor’s legitimate expectations does not constitute a breach of the international minimum
standard of treatment. In respect of indirect expropriation, section 3 of Annex 14-B states that such a determination requires a case-by-case, fact-based inquiry considering: (i) the economic impact of the host state’s action; (ii) the extent to which the host state’s action interferes with the reasonable investment-backed expectations of the investor; and (iii) the character of the government action, including its object, context and intent. Importantly, it also makes clear that non-discriminatory regulatory actions by states
designed to protect legitimate public welfare objectives (eg, health, safety and the environment) do not constitute indirect expropriation “except in rare circumstances.”

Conclusion – What Next for ISDS?
The USMCA has altered fundamentally the ISDS regime under NAFTA, and in several important respects has pulled-back on investors’ rights to bring arbitration against host states. While ISDS continues to survive, the USMCA appears to be part of a global trend narrowing the rights and remedies of investors under investment treaties.