The Negative Cost of ISDS on Canadian Sovereignty: NAFTA, Lone Pine, and Beyond

The Negative Cost of ISDS on Canadian Sovereignty:

NAFTA, Lone Pine, and Beyond

Hannah Johnston & Rena Taggar

This article is part of a two-part series on ISDS. CJCA blog posts represent the individual opinions and perspectives of their authors. The Canadian Journal of Commercial Arbitration does not maintain or publish a collective or institutional view on any legal or political issue.

While negotiating NAFTA’s successor, the Canada-United States-Mexico Agreement (CUSMA),[1] Canada effectively removed itself from investor-state dispute settlement (ISDS) with the United States. Lone Pine Resources Inc v Government of Canada[2] is one of the final cases to come through NAFTA’s ISDS system: a system that has caused considerable damage to Canada’s finances and sovereignty.

NAFTA Chapter 11: A Costly Venture for Canada

NAFTA Chapter 11, the “Investment Chapter” of the treaty (which has a partial equivalent in CUSMA Chapter 14), allows investors of one state party to bring claims against the government of another state party before an international arbitral tribunal.[3] Specifically, article 1121 ­waives the “local remedies” rule, meaning that investors do not need to exhaust any remedies before the courts or regulatory bodies of the state where they invested before they file Chapter 11 claims. This mechanism will remain available to Canadian investors in the US and American investors in Canada with respect to existing investments until 1 July 2023, three years after CUSMA’s entry into force on 1 July 2020.

Canada has been sued under Chapter 11 nearly twice as many times as the other two NAFTA members combined.[4] The reasons why Canada is such a frequent defendant are contested. The Canadian Centre for Policy Alternatives argues that it is because of Canada’s willingness to settle claims and pay debts that arise out of ISDS arbitrations.[5] Additionally, American investors appear to be more litigious: they have initiated 183 ISDS claims under a variety of investment treaties, yet the US has had only 17 claims brought against it.­[6] But Canadian investors themselves have initiated nearly twice as many claims as Canada has responded to.[7] Most likely, the explanation is simply that investors from developed countries bring more ISDS claims,[8] and many US investors have interests in Canada. Whatever the motivation, as of 2018, Canada had paid roughly $95 million in legal fees and $219 million in damages resulting from NAFTA Chapter 11 claims,[9] and it faces five remaining active claims.[10] One of these is Lone Pine, where the damages claimed total $118.9 million USD. 

Lone Pine: Illegal Revocation or Legitimate Public Measure?

Lone Pine Resources Inc, an oil company incorporated in Delaware, US, has brought an action against Canada regarding licenses to explore for oil and gas in the St. Lawrence River. These licenses had been revoked by a Quebec law, An Act to limit oil and gas activities (“the Act”).[11] The claimant argues that this revocation violated Canada’s obligations under NAFTA articles 1105 (Minimum Standard of Treatment) and 1110 (Expropriation and Compensation). Lone Pine claims they were not meaningfully consulted, that the Act “was explicitly politically motivated and blatantly ignored any meaningful consideration of investors’ legal rights”,[12] and that revoking the permit and denying compensation was “neither rationally connected nor necessary to serve the stated purposes of environmental protection and preservation of the St. Lawrence River.”[13] Conversely, Canada claims that the Act is a legitimate exercise of Quebec’s police power, supported by numerous studies that establish that the Act would protect the St. Lawrence River.

Lone Pine has not yet been decided. Proceedings were delayed by the untimely death of the chair of the tribunal, VV Veeder, who has now been replaced by Albert Jan van den Berg. A decision should be released soon.

Two recent NAFTA Chapter 11 cases, Mobil Investments and Clayton/Bilcon, point to a likely outcome, and they do not bode well for Canada.

In Mobil Investments Inc and Murphy Oil Corporation v Government of Canada, both investors held interests in offshore oil fields near Newfoundland.[14] Collectively, they claimed that the Government of Canada’s requirement that they carry out research and education to the benefit of the local Newfoundland economy, announced after hydrocarbon extraction began, would impose a $66 million loss from the profits they legitimately expected from their investments. The tribunal found that Canada’s Guidelines on Research and Development Expenditures were inconsistent with NAFTA article 1106(1)(c), which prohibits requirements “to purchase, use or accord a preference to goods produced or services provided in [a Party’s] territory, or to purchase goods or services from persons in its territory.”[15] The investors claimed, and the tribunal agreed, that funding education and research falls under these prohibited services. They were awarded $13.9 million and $3.4 million, respectively.

Mobil Investments demonstrates the willingness of ISDS tribunals to reprimand Canada for public interest measures which contradict the expectations of investors, as informed by the regulatory environment at the time the investment was made. If Lone Pine’s allegations are upheld, Canada may have to pay at least a portion of the damages claimed. Furthermore, the claimants in Mobil Investments had already challenged the Guidelines in Canadian courts and lost,[16] showing how ISDS claims may be used to circumvent Canadian judgements. The arbitral tribunals’ consequence-free disregard for Canadian courts undermines our national sovereignty. 

In Clayton/Bilcon Inc v Government of Canada,[17] investors proposed to construct a marine terminal in an environmentally sensitive area of Nova Scotia. Provincial and federal review boards notified Bilcon that they did not approve the proposal because of negative environmental impacts, and the investor responded by filing a Notice of Arbitration. A majority of the tribunal ruled that the environmental assessment review was discriminatory and violated minimum standards of treatment, as the local government had first encouraged and then rejected Clayton/Bilcon’s proposal, thereby frustrating the investors’ “legitimate expectations” under NAFTA Chapter 11.

Canada sought to set aside the award, but the Federal Court rejected its application.[18] The damages awarded were $7,000,000 USD. The lone dissenting arbitrator, Donald McRae, hinted that ISDS is weakening Canadian sovereignty, calling this decision a “significant intrusion into domestic jurisdiction” that “will create a chill on the operation of environmental review panels.”[19] A longtime professor at the University of Ottawa and advisor to several governments, including Canada’s, McRae has also been an arbitrator in at least 30 investor-state dispute settlement tribunals and is a member of the Permenant Court of Arbitration. His is a well-informed opinion.

Is ISDS a Fair Check on Government Excess or a Costly Attack on Sovereignty?

In the aforementioned cases, the Canadian government was assessed damages for taking steps intended to protect regional economies and the natural environment – a fact which no party contested. More serious than any legal fees or damages owing, the “cost” of ISDS for Canadians is that the risk of liability will “deter governments from acting in the public interest or distort policy choices towards options that are more amenable to foreign commercial interests.”[20] Indeed, proceedings under NAFTA Chapter 11 or the threat thereof have prompted Canada to repeal a ban of a suspected neurotoxin (MMT), decrease regulation of tobacco packaging, cancel plans for public automobile insurance in New Brunswick, and change environmental protection policy-making to prioritize trade concerns.[21]

However, some argue that NAFTA Chapter 11 and ISDS more generally have benefits that make them worth the cost. At the Canada-United States Law Institute Conference in 2000, international lawyer and White House official Daniel M Price spoke about ISDS and NAFTA Chapter 11 claims in their early days. He noted that ISDS allows investors to proceed with claims against states without having to ask their home government to bring a claim to the International Court of Justice—or worse, to engage in “gunboat diplomacy”.[22] The original goal was to depoliticize this arrangement and allow an investor to bring their claim directly against the state that had discriminated against them.

But unlike other countries that have bound themselves to ISDS, Canada has a strong rule of law and separation of powers. Price’s argument that ISDS depoliticizes disputes is inapplicable because Canadian courts are themselves depoliticized. Price states that “rather than being a threat to sovereignty, NAFTA checks the excesses of unilateral exercises of sovereignty by testing measures against generally accepted public international law standards.”[23] Such a claim is hard to credit when individual arbitrators are empowered to decide whether a Canadian regulation is justified using non-Canadian legal standards. 

Another purported benefit of ISDS is the absence of stare decisis, allowing arbitrators to take guidance from previous tribunals’ decisions without being bound by their reasoning. But such a system is unpredictable: Canada has won 9 and lost 8 of the concluded NAFTA Chapter 11 claims against it.[24] Price concluded: “I think fears or hysteria about overreaching arbitral panels are quite premature”, given the meager record of decisions.[25] Two decades later, the team spirit and equalizing principles behind NAFTA Chapter 11 have lost their appeal for Canada, the NAFTA party who has been hit the hardest.

Conclusion

Under the NAFTA Chapter 11 system, the decision in Lone Pine will likely reflect the ones that came before it, penalizing the Canadian government yet again for prioritizing its local economies and natural environment. Canadian CUSMA negotiators wisely removed Canada from NAFTA’s ISDS system, which has been continued by Mexico and the United States in CUSMA Chapter 14.

However, this does not mean that ISDS is dead; only that it no longer applies to Canada-US claims. Claims between Mexico and Canada will continue under the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).[26] CPTPP’s investment provisions are intended to reduce the scope of state liability and provide a safe harbour for regulations that may violate the literal terms of a treaty, provided that the regulations are undertaken in good faith and in the public interest. The government of Canada suggests that these provisions will help bring Canada’s preferred approach to ISDS forward, which includes a balancing of clear and enforceable rights for investors.[27] However, the true impact of these provisions is yet to be proven.

Canada also has ISDS obligations with other states through other treaties. But at least there will no longer be the disproportionate amount of ISDS claims brought against Canada by American investors.