Why the U.S. agreed to scrap NAFTA’s Chapter 11

Complex, sprawling international trade treaties like the new United States-Canada-Mexico Agreement, or USMCA (or NAFTA 2.0, if you find President Trump’s preferred title a little lumpy), can be difficult to sell to hardcore ideologues. Big treaties have a lot of moving parts; one side gives something up to get something, while the other side does much the same.

So USMCA has a couple of features that aren’t easy to file away as ‘left’ or ‘right’. Take, for example, the fate of NAFTA’s Chapter 11 — the ‘investor-state dispute settlement’ (ISDS) chapter that managed conflicts between nations and foreign investors.

ISDS clauses (there are about 3,000 trade treaties around the world that include them) allow foreign investors to sue governments over actions that void or limit their property rights. ISDS claims are arbitrated by ad-hoc panels of lawyers — not judges — chosen by both the state and investor parties. They operate outside of domestic court systems and don’t have to follow precedent. Their rulings can’t overturn government policy — but they can impose monetary penalties that can run to hundreds of millions of dollars or more.

USMCA mostly ends ISDS for the Canada-U.S. trading relationship; it will be available for existing investments for just three years before it is terminated. For new Canada-U.S. investments, it ends when (if?) Congress approves the deal.

The United States maintains an ISDS arrangement with Mexico, but its scope is being narrowed to cover only acts of discrimination against the investor after the investment is made, and acts of direct expropriation. More vague ISDS grounds available under NAFTA (like ‘fair and equitable treatment’) are gone.

(Canada also maintains an ISDS arrangement with Mexico through the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, or CPTPP — the 11-nation deal that replaced the TPP when the United States pulled out. It works roughly the way the old Chapter 11 did.)

It’s safe to say that critics of ISDS outnumber its fans on both ends of the political bell curve. Those on the left accuse the system of prioritizing the rights of corporations over elected governments, and of creating a state of ‘regulatory chill’ that makes those governments gun-shy about crossing foreign investors. Those on the right hate the idea of foreigners telling sovereign governments what to do outside the court system. For once, both sides are getting what they want … more or less.

One of those critics was caught by surprise. “Frankly, I was bowled over,” says Gus Van Harten. He teaches international investment law at Osgoode Hall and is one of the more prominent foes of ISDS in Canada.

“Canada is repairing one of the foundational mistakes in NAFTA.”

Not everyone is celebrating. John Boscariol is a partner at McCarthy Tetrault working in international trade law. He says it’s “unfortunate” that investors have lost a direct avenue to redress in USMCA because the alternative isn’t necessarily an improvement.

“The obligations states have toward investors are still there in the new agreement. It’s just that option to use the ISDS enforcement mechanism has been removed,” he says. “Now the enforcement of investment obligations will only be government-to-government.

“The argument for ISDS in the first place is that foreign investors frequently found themselves at the mercy of governments. ISDS didn’t require investors to bring their cases to government and ask them to incur the cost.”

Now, he says, Canadian investors active in the U.S. will either have to go “cap-in-hand” to Ottawa to ask for help, or take their chances with U.S. courts. “Not to say U.S. courts are always biased,” he adds, “but they tend to be aligned with domestic U.S. law more than the United States’ treaty obligations.”

The big, burning question about Chapter 11, of course, is why it was dropped while Chapter 19 — the dispute settlement mechanism that allows NAFTA exporters to bring anti-dumping and countervailing duty measures before an expert panel for arbitration — stayed alive in USMCA.

U.S. Trade Representative Robert Lighthizer has never made a secret of the fact that he loathes Chapter 19, seeing it as an unjust, possibly unconstitutional intrusion upon U.S. jurisdiction. In an administration that loudly proclaims the mantra of “America first,” he’s hardly alone.

But the United States has never lost a Chapter 11 case. Chapter 19, meanwhile, has sometimes let Canada down. In the early 2000s, Canadian lumber exporters took their case against U.S. duties to a NAFTA panel. They won. But since the U.S. didn't want to comply, Canada negotiated a settlement. After that settlement expired, the U.S. Commerce Department revived the duties, and the whole dispute started from scratch.

“I think that, in the end, this all came down to what President Trump wanted and what he cared about,” says Cyndee Todgham Cherniak of LexSage, an international trade and tax law firm.

“He just wasn’t as wound up about getting rid of Chapter 19 as his negotiators were. He got what he wanted on autos and dairy and he didn’t really care about the sovereignty argument. He saw Chapter 19 as temporary leverage.”

Van Harten, meanwhile, says it’s “nothing short of remarkable” that Lighthizer himself appears to have absorbed an ISDS critique popular on the left — that its rulings make governments reluctant to make policy in the public interest that constrains private foreign investment. Questioned about Chapter 11 at a House Ways and Means Committee hearing in late March, Lighthizer seemed to suggest that ISDS poses a threat to democracy itself:

“People will respond ‘Well we haven't lost cases in the United States in our position,’ and while in fact that is the case, we have come close to losing some.

“But more importantly, we've had situations where real regulation which should be in place which is bipartisan, in everybody's interest, has not been put in place because of fears of ISDS. So I think it is something we have to think about very carefully.”

Doug Beazley is a regular contributor based in Ottawa.