NAFTA Reform, Investor-State Dispute Settlement, and Environmental Regulation

Canada, the United States, and Mexico are set to begin the re-negotiation of the North American Free Trade Agreement (“NAFTA”) in August. The foreign investment protection chapter (Chapter 11) is likely to be among other contentious aspects of the treaty to be addressed.

Chapter 11 protects certain investments made in one of the party states by investors of another party state. Chapter 11 provides a range of protections to investors, including national treatment (Article 1102; investors of another party state must be treated in as favourable a manner as national investors); most-favoured-nation treatment (Article 1103; investors must obtain treatment no less favourable than that afforded to investors of any party or non-party state); minimum standard of treatment (Article 1105; investments of investors from another party state must be made in accordance with standards international law, including fair and equitable treatment and full protection and security); and freedom from direct or indirect expropriation of an investment (Article 1110).

When an investor believes that its rights under Chapter 11 have been violated by a party state, it can directly sue the party state through the investor-state dispute settlement (“ISDS”) process provided for in Chapter 11. Through this process, an ad hoc panel of arbitrators determines whether one or more of the Chapter 11 standards have been breached and if so, what damages the party state owes to the foreign investor. Party states do not have the capacity to sue or counter-sue investors under the current system.

Chapter 11, and ISDS more broadly, is often the subject of criticism, including its impacts upon environmental regulation. State actions and regulations relating to environmental protection have formed the basis of many lawsuits under Chapter 11, as well as under provisions in similar investment treaties. These lawsuits have resulted in significant damages awards against states.

Canada, more than either Mexico or the United States, has frequently found itself on the receiving end of such lawsuits, most often by US investors. Recent analysis shows that about 60 per cent of those challenges were aimed at environmental regulations or resource management policies.

For example, a recent arbitration tribunal awarded a US investor CAD $25,182,900 in damages and CAD $2,912,432 in costs in relation to the Ontario government’s decision to impose a moratorium on off-shore wind turbine projects.

Canada also recently lost a NAFTA Chapter 11 arbitration initiated by a US investor whose proposed project—a quarry in Digby Neck, Nova Scotia—failed to receive the necessary approvals to move forward following an environmental assessment.

Many commentators have warned that the threat of litigation can have a chilling effect on a state’s freedom to regulate in the public interest. Regulators may hesitate to introduce or enhance environmental regulations for fear they will be challenged under Chapter 11. Some argue that environmental regulation is particularly vulnerable to this effect.

Although details remain unconfirmed, it appears very likely that Chapter 11 reform will be part of the NAFTA re-negotiations. It is unlikely that investor protections would be scrapped altogether, but some of the procedural aspects of ISDS are a likely candidate for reform.

Despite public and academic criticism, it is unlikely that reforms efforts will be aimed at shielding state environmental regulation from Chapter 11 challenges.