The State Department published the NAFTA award in Grand River Enterprises Six Nations, Ltd. et. al. v. United States of America last week, a month after it was dispatched privately to the parties. The case was brought against the United States by a Canadian tobacco corporation that sold tobacco on reservations in the U.S. and three Canadian members of the Haudenosaunee indigenous group who owned or did business with the corporation. The claimants argued that implementation of the deal that U.S. states made with tobacco companies in the 1990s and later to address underage smoking and public health concerns about tobacco violated their NAFTA rights. The award, and other associated documents, is available here: https://www.state.gov/s/l/c11935.htm
While the United States thankfully prevailed in the case, the award raises serious concerns about NAFTA-style investment rules. Among the top concerns from my initial read of the award:
Even when governments win NAFTA disputes on the merits, taxpayers are on the hook for the multi-million dollar costs of arbitration. In this case, U.S. taxpayers had to cover nearly $3 million in legal and arbitration fees, despite the U.S. emerging victorious. (paragraph 241) The investor-state system is becoming so expensive that hedge funds are creating special financing vehicles to loan money to corporations and individuals pursuing attacks on national policies. While private companies can profit off of this system, taxpayers are left with nothing but liability for these often meritless claims.
NAFTA attacks allowed against public health measures. The U.S. states’ settlement with the tobacco companies was a complex response to a complex political and regulatory problem. In 1998, 46 U.S. states entered into a settlement agreement with Philip Morris Inc., R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corp., and Lorillard Tobacco Company, (“participating manufacturers” or PMs) to resolve claims that the states had filed seeking to recoup medical expenses incurred for treating smoking-related illnesses of indigent smokers and to pay for smoking reduction programs. As part of the settlement agreement, the PMs agreed to pay the states over $246 billion over the next 25 years, and to restrict marketing directed at children.
But there was a feature of the initial legislation that inviting companies to game the system. According to the panel report:
“15. As initially adopted, the escrow laws included "allocable share" provisions that could significantly lower the amount to be escrowed in a given state. These provided that an NPM need not escrow in any state more than that state would have received in respect of that NPM's total sales in all MSA states, if the NPM were a PM. This greatly reduced the amount to be escrowed by NPMs that concentrated their sales in a few states. This is because each state's share of MSA funds reflects its proportionate share of total national cigarette sales covered by the MSA regime. Thus, for example, a state with 1% of all national sales of covered cigarettes receives 1% of all funds paid in by the PMs. If a NPM sold all of its cigarettes in that state, it would have to escrow in that state an amount approximating the amount that it would have paid to the national MSA fund were it a PM. However, thanks to the allocable share provisions, the NPM would then receive an immediate release of 99% of the escrowed funds, because the state would receive only 1% of the NPM's payments were it a PM.
16. This feature of the MSA allowed a NPM concentrating its sales in a few states to recoup most of the funds it placed in escrow. The Parties disputed whether this was inadvertent (as contended by the Respondent) or intentional (as contended by the Claimants). Several of the Respondent's witnesses testified at the hearing that it was inadvertent, and that the MSA was designed on the incorrect assumption that any future NPMs would pursue a national marketing strategy. (At the time of the MSA, the U.S. cigarette production was almost entirely in the hands of firms of national scope.) Claimants maintained, however, that the allocable release provisions were intentionally included in the MSA in order to "level the playing field" between NPMs and exempt SPMs…
19. There followed a substantial reduction in PMs' sales and market share, and an increase in NPMs' sales and market share. There was undisputed evidence indicating that the total market share of NPMs like Grand River grew to 8.1% of the U.S. market in 2003. This threatened the states' revenues under the MSA, and also resulted in increased sales of lower-price cigarettes not subject to the MSA's restrictions on advertising, youth marketing and the like. The Parties disputed whether such factors related to health played any significant role in the states' subsequent actions. The Claimants contended that the states acted solely or primarily to protect their MSA revenues; the Respondent contended that considerations of public health were important motivating factors.
20. States participating in the MSA responded to the growth of NPMs' sales by intensifying efforts to enforce their escrow laws. In addition, late in 2001 and early in 2002, they began to enact "complementary legislation" (referred to by the Claimants as "contraband laws") to strengthen enforcement of the escrow laws. These statutes required state attorneys general to maintain lists of NPMs not in compliance with the escrow laws, and prohibited state stamping agents from placing tax stamps on cigarettes from non-complying manufacturers. Cigarettes not stamped for sale became subject to forfeiture as contraband.
21. Beginning in 2003, states also began to amend the escrow laws to repeal the allocable share provisions. The states came to regard these provisions, which authorize substantial rebates of escrowed funds to NPMs which concentrated their sales in a few states, as a "loophole," and the evidence indicated that 38 states had adopted amendments to "plug the loophole" by September 2004. As noted above, the Claimants denied that the allocable share provisions were a loophole, contending instead that they were deliberately included in the MSA to "level the playing field" between NPMs and exempt SPMs.”
On March 12, 2004, the Grand River petitioners filed a NAFTA claim, seeking $340 million in compensation for alleged violations of NAFTA Chapter 11 at UNCITRAL, a dispute settlement facility at the United Nations. The claimants argued in a general way that the major tobacco firms conspired to ensure that NPMs were covered by the terms of the settlement and secured terms that are more favorable to PMs than NPMs in an effort to force small firms out of business and corner the market. Specifically, the claimants argued that payments into state escrow accounts constitute an expropriation in violation of NAFTA Article 1110. Additionally, the claimants argued that their investment was expropriated because its cigarettes cannot be sold in states where it does not comply with state escrow laws. The claimants also alleged they were deprived of fair and equitable treatment under Article 1105 as they were not notified of the settlement negotiations, nor were allowed to participate in negotiations, yet are bound by the terms of the settlement. Grand River also argued that it is being discriminated against in violation of Article 1102 because domestic firms that participated in the settlement are operating in the U.S. without contributing to an escrow fund. Lastly, Grand River claimed that the U.S. has violated Article 1103’s most favored nation provision because other foreign firms (presumably selling other products than tobacco) are not required to maintain an escrow account while doing business in the U.S.
The claimants advanced the argument that the tobacco settlement targeted tobacco companies like Grand River, “without in fact advancing legitimate health interests.” While not ruling specifically on this count, two members of the tribunal opined that “the evidence before it leaves open to question whether the MSA scheme has in fact produced substantial health benefits for the participating states.” (paragraphs 182-183) But largely due to the tobacco settlement, teen smoking is plummeting in the U.S. Today, under 20 percent of U.S. high school students report being smokers, compared to 36 percent in 1997. For a tribunal to even accept a case on such a sensitive area of public health demonstrates the threat that NAFTA-style rules impose.
Individuals with minimal to no job-creating investment (socially useful or otherwise) allowed to avail themselves of special NAFTA rights. Two of the individual claimants (Jerry Montour and Kenneth Hill) operated a Canadian manufacturing facility in Canada that exported tobacco to the United States. The tribunal decided that they were not investors in the United States for the sake of NAFTA, but cited NAFTA provisions that would have likely granted them that status if they had simply gone the additional step to register a corporation or make a loan within the United States. (paragraphs 82-89, 106, 122)
Arthur Montour, the third individual claimant, was deemed an investor with a U.S. investment. In this case, the major relevant difference from the other claimants was that he owned a company (Native Wholesale Supply, NWS) registered in the Sac and Fox Nation territory in Oklahoma and operating out of New York state. His company purchased and imported Canadian tobacco from the other claimants, and then sold them to wholesalers and retailers on Indian reservations throughout the United States. (Paragraph 24) Moreover, NWS owned a trademark to the Seneca® tobacco brand. (Paragraph 118, 120)
The award does not report whether NWS created jobs for anyone other than Arthur Montour, or that the company contributed to U.S. society in any way. Much of the claimants' business model seemed to be based on gaming the escrow system. Moreover, as the panel wrote, “The Claimants’ Memorial… indicates that the Claimants structured their business to minimize tax liability in both the United States and Canada…” (Paragraph 98) Despite these facts, the Grand Rivers tribunal decided that Arthur Montour had an investment that qualified for special NAFTA protections. While NAFTA forbids governments from imposing so-called “performance requirements” that condition investment authorization on giving back to the foreign investor’s adopted community, the pact is very clear that even investors with little more than a P.O. box presence can avail themselves of the excessive NAFTA protections.
NAFTA allows attacks on fundamental questions involving the U.S. Constitution and sovereignty. The claimants in the Grand River case argued the U.S. Constitution, U.S. legal norms and various U.S. treaties establish that U.S. states cannot regulate commerce on and between Indian reservations. A large part of the claimants’ business was selling cigarettes on reservations, and they argued that state requirements that tobacco companies deposit certain amounts in escrow accounts to cover potential liability violated their NAFTA-protected expectations of how they should be treated, given their interpretation of the treaty and legal precedents. The State Department disputed these arguments. The tribunal, while acknowledging the sensitivity of the constitutional questions involved, nonetheless felt itself competent to decide that “U.S. domestic law is currently far from conclusive about the question raised here of the extent of permissible state regulation.” (paragraph 138) The tribunal went on to state that “If a national court system fails to address these questions in a proper way,” then an unelected investor-state tribunal established outside of the U.S. Constitution could review domestic court practice to see if it violated NAFTA foreign investor rights. (paragraph 234)
Cases like this are likely to lead to further questioning by U.S. jurists and legal scholars as to the very constitutionality of NAFTA’s investor-state foreign investor protection system. Article III of the U.S. Constitution creates an independent judiciary, separate from the legislative and executive branches of the federal government. Former U.S. Supreme Court Justice Sandra Day O’Connor has questioned the delegation of Article III authority to an increasing number of trade tribunals. “Article III of our Constitution reserves to federal courts the power to decide cases and controversies, and the U.S. Congress may not delegate to another tribunal ‘the essential attributes of judicial power,’” said Justice O’Connor. In 1982 the Supreme Court declared that establishment by Congress of federal bankruptcy courts was a delegation of the constitutionally granted power of the judiciary too extreme to pass constitutional muster. Many scholars and jurists believe that the NAFTA Chapter 11 tribunals, which have extraordinary powers to review local, state, and federal policies and decisions as well as judicial decisions including those of the U.S. Supreme Court, represent an even more radical delegation of “the essential attributes” of the judiciary. The Conference of Chief Justices passed a resolution stating “The question of whether the investor-state process is consistent with Article III of the U.S. Constitution raises a sufficiently serious and important issue that deserves prompt, thorough examination as the United States considers negotiating additional trade agreements with various other nations.” Or, as Abner Mikva, former U.S. federal judge and one-time NAFTA panelist, told the New York Times, “If Congress had known that there was anything like [Chapter 11] in NAFTA they would never have voted for it.”
State governments – who did not negotiate or formally agree to NAFTA – remain bound by its rules. Whether the measure at issue is the state tobacco settlements (as in this case), or state environmental regulations (as in other key NAFTA investor-state cases), states are reliant on the federal government to defend state-level policies, even when the federal government’s policy position may be at odds with that of the state legislature.
Obama administration ranks investor protection over indigenous rights, while tribunal feels free to second guess regulators. The claimants cited indigenous rights and human rights law in support of the notion that state regulators should have obtained the “prior informed consent” of indigenous communities before enacting the tobacco settlement. (paragraph 182) In a counter-memorial from December 22, 2008, in the final days of the Bush administration, the State Department argued vigorously against this notion. The department cited objections by China and Colombia – which have well-documented abuses of indigenous groups – as support for the notion that instruments like “the United Nations Declaration on the Rights of Indigenous Peoples, which calls for consultations with indigenous peoples, does not represent customary international law, while pointing out that the United States voted against the Declaration when the General Assembly adopted it in 2007.” (paragraph 200, 210 of award; page 135-137 of counter-memorial). The counter memorial went on to say:
“The United States clearly rejected “any possibility that [the Declaration] is or can become customary international law” and emphasized that because the Declaration “does not describe current State practice or actions that States feel obliged to take as a matter of legal obligation, it cannot be cited as evidence of the evolution of customary international law.” The United States further emphasized that “[t]he flaws in this text run through all of its most significant provisions” and because “these provisions are fundamental to interpreting all of the provisions in [the] text, the text as a whole is rendered unworkable and unacceptable.490 The United States specifically observed, with respect to the consultation obligation under Article 19 of the Declaration, that the obligation “could be misread to confer upon a sub-national group a power of veto over the laws of a democratic legislature by requiring indigenous peoples[’] free, prior and informed consent before passage of any law that ‘may’ affect them.”” (page 137)
The Obama administration, when asked about the U.S. position, stated on February 13, 2010, that “The U.S. position that customary international law does not include the duty to consult alleged by Claimants has been repeated publicly and is well known.” Page 2176, https://www.state.gov/documents/organization/142066.pdf
The tribunal, for its part, argued that – regardless of whether indigenous rights formed part of customary international law – the consultation requirement does not extend to individual indigenous investors, but rather indigenous communities as a whole. (paragraph 213) But the panel nevertheless went on to opine that “U.S. states… do not appear to have been at all sensitive to the particular rights and interests of the Claimants or the indigenous nations of which they are citizens…” (paragraph 186)
The arguments presented in the Grand Rivers case are likely to frustrate many distinct constituencies. The Obama administration received accolades for its decision to endorse the UN Declaration in December 2010. But indigenous communities will be discouraged that the administration has simultaneously a dismissive view of its import, and that rather only certain investment obligations rise to the level of “customary international law.” In the debate around the U.S.-Peru FTA, a major sticking point is whether Peru has the obligation to consult with its indigenous communities (who have consultation rights under the UN declarations and ILO conventions) when reducing barriers to U.S. oil companies (who have FTA investor rights). The Obama administration’s position appears to be that only the investment rights would take the status of customary international law.
Meanwhile, U.S. regulators are likely to bristle with the panel’s contention that they should be “sensitive” to the concerns of tobacco companies on the basis of indigenous rights principles, even when U.S. regulators are trying to reduce public health hazards that harm indigenous peoples.
State Department Continues to Undermine Arguments Behind May 10 Deal. Despite changes made as a result of the May 10, 2007 deal between the Bush administration and certain congressional Democrats, the Peru, Panama, Colombia and Korea “free trade agreement” (FTA) Investment Chapters are almost identical to the CAFTA Investment Chapter, except where they are worse. There was one addition made to the preambles of these FTAs, however, that related to investment obligations. It read that the parties… “AGREE that foreign investors are not hereby accorded greater substantive rights with respect to investment protections than domestic investors under domestic law where, as in the United States, protections of investor rights under domestic law equal or exceed those set forth in this Agreement…”
There is no certainty as to the legal meaning of this provision, and historically preambular provisions (especially pro-public interest ones) have been given little to no weight by investor-state tribunals under U.S. FTAs or “bilateral investment treaties” (BITs). Over 90 percent of panels under investor-state cases under U.S. trade and investment agreements ignored the preamble, selectively paid attention only to pro-investor clauses, or found that preambular provisions were purely hortatory. The panels in the remaining cases found that pro-investor provisions had to be given as much or more weight as pro-public interest provisions. The panel in Grand River took this approach (paragraph 69).
Interestingly, the U.S. State Department may be the biggest barrier to the May 10 language being given any meaning. On May 1, 2007, in the NAFTA panel in the Canadian Cattlemen for Fair Trade vs. the United States, the U.S. State Department lawyers argued that: “Although the preamble ... may inform the construction of provisions in NAFTA Chapter Eleven, they are not capable of transforming the nature of those obligations, or of imposing independent ones on treaty signatories.”
In September 2007, in the Glamis case, the U.S. State Department noted the pernicious influence of preambular language, arguing that: “We do not believe that the standard that’s articulated in those cases is reflective or has been shown to be reflective of the minimum standard of treatment under customary international law. Many of those Tribunals explicitly state that they are not tying the standard to that. And when they have gleaned the standard, as far as we can tell, many of them have looked at language from the preamble and have basically elevated that into a standard without examining State practice. Now, this is much like what the Metalclad Tribunal did with respect to the transparency language that's in the preamble.”
In December 2008, the U.S. State Department stated: “the key to interpreting the provisions of the NAFTA must be the text itself, as informed by the treaty’s context, object, and purpose, only to the extent those additional sources are relevant to, and consonant with, the substantive provision at issue. This approach is grounded in the well-accepted principle that general objectives can shed light on treaty provisions, but cannot impose independent obligations on treaty signatories.”
The U.S. State Department returned to this line of argument in the Grand River case. (see page of 90 of U.S. submission - https://www.state.gov/documents/organization/114065.pdf )
If the United States attempted to invoke the new May 10 preambular clause as part of its defense in a future arbitral proceeding, the claimant and tribunal would undoubtedly cite these State Department arguments to attack the defense.
Panel fails to resolve role of investor expectations. As noted above, the claimants cited treaty and other precedents as underlying their alleged expectation of being able to continue to game the escrow accounts. The U.S. State Department fairly aggressively made the case that, “As a matter of international law, although an investor may develop its own expectations about the legal regime that governs its investment, those expectations do not impose a legal obligation on the State.” This is a positive line of argumentation. But the panel did not directly speak to the issue, suggesting that instead the investor may have been able to develop expectations that impose a legal obligation, if the expectation had been based on clearer U.S. jurisprudence on state-federal-tribe relations (paragraph 144).
Panel fails to establish that “expropriation” must destroy 100% of the value of an investment. Another key issue in debates around regulatory takings / indirect expropriation is whether 100 percent of the value of an investment has to be destroyed in order to constitute an expropriation. The panel left the door open to runaway indirect expropriation claims by stating that deprivation “of a very great measure of a claimant’s property interests” could constitute an expropriation. (paragraph 154)
Panel fails to resolve overreaching definition of discrimination. The claimants argued that the non-discrimination obligations in NAFTA should be construed “in a broad and remedial fashion.” As the panel reported, “In [the claimants’] view, these provisions do not require a showing that differences in treatment were imposed on account of nationality, or that contested measures had a disproportionate impact on foreign investors.” Instead, the obligation is to provide the best possible treatment as provided to any investor in like circumstances. (paragraph 161)
The State Department thankfully argued that “a claimant must make some showing that the alleged difference in treatment was on account of or related to a foreign investor’s nationality.” The panel refused to adopt either interpretation. (paragraph 171)
Panel fails to resolve scope of taxation carve-out in FTAs. The United States argued that some of the measures challenged by the claimants were taxation measures that should be excluded from the terms of the agreement. (Page 70-71 of U.S. Counter-Memorial.) There is substantial uncertainty as to what types of taxation policies are carved out under FTAs and BITs, and to what extent. The panel also refused to clarify that point. (paragraphs 123-124)
In sum, at a time when state and federal legislators are contemplating severe cuts to basic social services and law enforcement agencies, it is unconscionable that three unelected panelists would hold the U.S. liable for these multi-million dollar fees. Congress should reject the NAFTA-style deals with Korea, Colombia and Panama, which contain virtually identical investment rules that could put U.S. taxpayers on the hook for unlimited amounts of cash to foreign investors. Moreover, as congressional budget authorization and appropriations committees look for ways to reduce the State Department budget, they should consider prohibiting any expenditure related to NAFTA-style investment rules until these rules are eliminated or renegotiated to better protect the public interest.