United States-Mexico-Canada Agreement: Fragmentation and Curtailment of Investor State Dispute Settlement

Image credit: Flag of the North American Free Trade Agreement by Keepscases (CC BY-SA 3.0) via Wikimedia Commons.  

David Earnest, Shearman & Sterling LLP

12th December 2018

The Trump administration took a step towards clarifying its position on investor state dispute settlement (ISDS) when, on 30 November 2018, the United States, Mexico, and Canada entered into the United States–Mexico–Canada Agreement (USMCA). The USMCA departs significantly from the North American Free Trade Agreement (NAFTA) by curtailing investor’s access to ISDS, narrowing the substantive protections available for investments, and imposing an exhaustion of local remedy requirement as a precondition to ISDS.

On the face of the USMCA, it is unclear whether departures from the broad availability of ISDS in NAFTA are the result of the Trump administration’s ‘America first’ approach to international trade, or if this actually represent a broader shift internationally towards a narrowing of ISDS. What is clear, however, is that if the USMCA ultimately enters into force (which is not a foregone conclusion), the role of ISDS and associated investment protections as between the United States, Canada, and Mexico will be very different from what has been available under NAFTA for the past quarter-century.

Existing ISDS Claims

The USMCA leaves existing ISDS cases undisturbed and allows investors to bring claims on qualifying ‘legacy investments’ for a three-year period after NAFTA’s termination. Once that sunset period ends, an investor’s ability to assert an investment claim in ISDS is dependent on the investor’s nationality and the type of investment.

Canadian Investment

US and Mexican investors in Canada, and Canadian investors in the US and Mexico, would no longer be able to initiate an investment arbitration under the USMCA. Rather, unless those investors are able to structure their investments through other countries with applicable investment treaties, they will have to rely on national courts or state-to-state arbitration to pursue investment claims. This has the potential to disproportionately disadvantage US investors since they have brought the majority of the claims under NAFTA and the US has never (to date) lost an ISDS claim under NAFTA.

Canadian investors in Mexico and Mexican investors in Canada may be able to avoid the USMCA altogether for ISDS by instead asserting claims under the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) once it enters into force for the initial ratifying members on 30 December 2018. The CPTPP is the successor to the Trans Pacific Partnership (TPP) that the Trump administration withdrew from on 23 January 2017.

United States and Mexican Investment

While the USMCA maintains ISDS for US investors in Mexico and Mexican investors in the US, the substantive protections in the USMCA for these investors have been substantially curtailed. Specifically, ISDS will only be available for claims concerning national treatment, most favoured nation treatment (MFN), and for direct expropriation relating to established investments. However, national treatment and MFN claims will not be allowed if they relate to the establishment or acquisition of an investment. Notably, ISDS is not available for claims relating to indirect expropriation and a violation of the fair and equitable treatment standard, two of the most frequently asserted legal bases for ISDS claims.

The USMCA also requires an investor to pursue its claim ‘before a competent court or administrative tribunal of the respondent’ until a ‘final decision from a court of last resort’ or 30 months have passed from the date the local proceedings were initiated. This temporal exhaustion of a local remedy requirement could significantly delay, and potentially inhibit, access to ISDS (although investors are likely to try to avoid this provision through the use of the USMCA’s MFN provision).

The availability of ISDS under the USMCA is further fragmented by provisions that allocate a specific subset of US and Mexican investors broader ISDS access and substantive protections (e.g., for indirect expropriation) to investments that qualify as ‘covered government contracts’ in specific sectors. The covered sectors are oil and gas, power generation, telecommunications, transportation, and certain infrastructure investments. There is also no exhaustion of local remedy requirement for these claims.

Other ISDS Changes

The USMCA contains a number of other changes that affect the procedure and scope of ISDS, such as:

• a variation to the definition of ‘investment’ and ‘claimant’;
• a four instead of three year limit to bring claims;
• greater ISDS transparency;
• arbitrations may be seated in non-USMCA States;  limits on interim or final relief that an arbitral tribunal may order or recommend; and,
• final awards may only be enforced once any revision or annulment proceedings are finalized or time-barred.

The USMCA also notably requires arbitrators to comply with the IBA Guidelines on Conflicts of Interest in International Arbitration, including guidelines regarding direct or indirect conflicts of interest.

Overall, if enacted in its current form the USMCA has the potential to create a paradigm shift that curtails the ISDS protections historically afforded under NAFTA. Whether these changes represent a broader change in policy, or were the result of ad hoc bargaining to get the USMCA across the finish line by the current US, Mexican, and Canadian administrations, remains to be seen.

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David Earnest is an attorney in Shearman & Sterling LLP’s International Arbitration Group and is based in Washington DC. The views expressed herein are those of the author and shall not be attributed to Shearman & Sterling LLP or its clients.