A NAFTA proposal: fix the FET investment protection commitment

International Economic Law and Policy Blog | 27 September 2017

A NAFTA proposal: fix the FET investment protection commitment

by Mona Pinchis

With the NAFTA negotiations, investment lawyers, lawmakers, business groups, and civil society are waiting to see how Canada, Mexico, and the US will address the heated topic of investor-State arbitration, where an investor can claim compensation directly against a host state based on a treaty breach before an ad hoc tribunal (ISA). Today, a considerable number of ISA claims arise from the commitment to accord fair and equitable treatment (FET) to covered investments. Without a multilateral investment treaty, UNCTAD has mapped over 2,000 treaties that contain FET and ISA. With a wealth of literature, investment treaties, and ISA awards still failing to define FET, the attention to reform ISA misses a key part of why ISA flourished: the vagueness of FET.

Just this morning, Rob Howse alerted to the news that Canada is considering dropping FET from its proposed NAFTA Chapter 11 text. This post will draw upon my archival research into the development of FET in early twentieth century investment law to elaborate three different options for reform of NAFTA Article 1105(1):

Article 1105: Minimum Standard of Treatment

Each Party shall accord to investments of investors of another Party treatment in accordance with international law, including fair and equitable treatment and full protection and security.
Based upon my doctoral research into thousands of internal government deliberations, treaty and policy drafts, and business proposals from 1919 to 1956, one finding of my work was the disconnect between the early roles of FET in investment law and its contemporary counterpart. But, if that’s the case, then why should States continue to rely upon the language and formulation of FET clauses? Are States ‘locked in’ to FET?

My archival work elaborated on several roles for FET at the time. It highlighted when and how trade treaty architects (largely economists and trade lawyers) used the concept of FET in treaties in two situations. First, when contracting states could not agree on a specific treaty rule for certain trade topics. For instance, in the context of post-war, state parties relied on FET when they could not agree to a commitment of equality of treatment for state trading. Second, when contracting states recognized that precise rules could not capture every contingency and required broadness and vagueness (incompleteness in contract theory) to allow for the resolution of problems ex post. While not the entire story for FET, this history shaped how these architects turned to investment law as a natural kin to trade.

Of course, there’s more than one way to plug contractual gaps. Indeed, FET was not the choice standard for review of state actions in the context of the international investment provisions for the Charter of the International Trade Organization (ITO). In that case, the drafters relied on the standards of ‘reasonableness’ and ‘justness’ to evaluate capital-importing and capital-exporting states’ actions upon international investment. For instance, the London Charter draft required Members to impose ‘no unreasonable impediments’ to the obtainment of capital and facilities required for economic development, and commit to ‘take no unreasonable action’ injurious to the interests of other Members or persons. (Report of Joint Committee on Industrial Development, E/PC/T/23). And, while there was trouble translating these standards in French and Spanish, ‘reasonableness’ and ‘justness’ were prioritized over the concepts of ‘fairness’ and ‘equitable treatment’ (and equality of treatment) to capture the tension between preserving a state’s domestic policy choices and the desire to provide the investment protections necessary to promote foreign investment. ‘Equitable treatment’ remained important, but as a guiding principle by which the ITO would make recommendations for Member states’ future international investment agreements.

In short, ‘reasonableness’ trumped ‘equitable treatment’. For instance, when there was a Charter proposal to replace a proscription against ‘unreasonable action’ with ‘unfair or inequitable action’, several States associated these terms with the common-law concept of equity, and rejected this obligation. Later, a US architect of the Charter’s investment provisions privately mused that the choice of ‘unfair or inequitable’ was just more ‘legalistic’ than the terms ‘unreasonable and unjustifiable’. What was agreed to was FET as a general statement or principle, a placeholder if you will, for more precise rules developed by contracting states following the establishment of the ITO.

FET took on different roles in the US post-World War II friendship, commerce, and navigation treaties. As the US negotiated more of these treaties and further refined its investment policy, FET was initially transplanted from its trade-past to investment, and used as a ‘general statement’ in a proscription against ‘unreasonable or discriminatory’ State measures. Thereafter, the US cited to FET as a ‘general outlook’ to the treaty ‘as a whole’, and a ‘preambular link’ between the treaty’s preamble and the core treaty commitments. Early post-WWII US investment policy substituted MFNT and NT commitments with a ‘general statement’ of FET and non-discriminatory treatment. However, by 1950, in negotiation with Japan, the US was clear that FET was not equal to a third standard of treatment. This confirmed that it was not equal to national treatment (NT) or most-favoured-nation treatment (MFNT), and suggested it was not equal to a minimum standard of treatment (MST). In negotiations with Germany and Japan, the US cited FET as a ‘guiding principle’ for a ‘just’, ‘equitable’, or ‘liberal’ interpretation of the treaty. While there was no direct connection between MST and FET, there was limited archival evidence that FET could serve as a gap-filling protection, particularly against arbitrary treatment that escaped other ‘adequate standards of treatment’. While failing to provide precise commitments to US investors, the US nevertheless argued that FET could serve as a basis for complaint when US interests abroad were harmed by a contracting state’s actions. Regardless, there was no clear indication that a breach of FET entitled investors to compensation, and any possible complaint arising from FET (which was believed to be in extreme and limited circumstances) was intended for inter-state means of dispute settlement.

This brief historical reflection suggests that FET was useful as a tool to bring States to the negotiating table and resolve disputes on an inter-State level. From the moments in time I studied, private actors could not bring FET complaints via ISA. It also demonstrates that the contracting states recognized a need to inject some flexibility in these early investment provisions, such as with the use of FET. For the US, vagueness in the treaty was not the first choice, but the best choice at balancing the competing objectives of economic development and the expansion of world trade against the demands of US business for stronger rules of investment protection. Plus, there was the expectation that any gaps in the treaties would be filled in with future negotiations and adjudication. Therefore, while there was no clear role or meaning for FET in early investment law, FET was included in investment treaties for states to address controversies and unknowns within this developing area of law. It was not a catch-all obligation meant for resolution via ISA.

Considering this, I submit for discussion three options for addressing NAFTA Article 1105.

First, the Canadians have paid attention to recent disputes, and it is clear from the recently completed Canada-China and Canada-EU treaties that the trend is towards modernizing FET with a precise list of protections for covered investments (with or without a reference to customary international law). See, for instance, Article 8.10(1) and (2) of the EU-Canada agreement. This approach would appeal to those states seeking to set specific parameters to FET up front, and removes the unknowns associated with allowing a third party to interpret and apply an open-ended FET. Taking this approach further, the NAFTA parties could consider removing the reference to FET/MST altogether. Instead, they could focus only on those discrete elements the parties agree represent the modern FET concept. For instance, due process requirements, access to justice, abusive treatment to investors, and targeted non-discrimination. As FET was originally included to allow contracting states to address contingencies, but bearing in mind the existence of ISA, the NAFTA parties could retain the Canada-EU treaty mechanism that enables the parties to revise the list, allowing the treaty to evolve over time (article 8.10(3)).

The Canada-EU model captures a valuable attempt to further refine the rules, something championed by international investment scholars. Creating more precise rules and limiting the ability of a tribunal to decide the elements of FET would satisfy the ‘America first’ sovereignty-push by the US Trump administration, which recently expressed distrust in ‘unaccountable’ tribunals (which as Simon has noted has been a slow attack upon the WTO dispute settlement system).

Second, and related to the US’ questioning of the existing WTO dispute settlement system, last week Ambassador Robert Lighthizer spoke about the pre-WTO GATT dispute settlement system. This harkens back to the original ITO approach of diplomacy and inter-State dispute resolution (exactly the context from which FET appeared in the ITO Charter investment provisions). Therefore, another approach could appeal to this desire by maintaining FET in Article 1105, but removing it from the purview of ISA, leaving investors free to seek compensation via the other substantive protections.** An example of such a reformed clause would be:

Each Contracting Party will accord fair and equitable treatment to the other Contracting Party; and will commit to consultations or other peaceful means of dispute resolution [identified within a different section of the treaty] in the event that one of the Contracting Parties considers the other Party has modified or impaired the objects of the Treaty or any of the benefits accrued to them through the Treaty’s commitments.

Such a commitment would allow States to address circumstances that may upset the overall balance of the treaty. It would also permit States to address which circumstances require reform to the treaty without costly renegotiation. Moreover, this proposal would still permit States to cover adverse effects caused by a contracting state’s measures on foreign investors. For instance, by maintaining the ‘promotion of investment’ within its preamble, contracting States could initiate a complaint via the FET clause due to the impairment of this objective, thereby continuing to protect investors’ rights and interests where manifestly arbitrary treatment has occurred.

Finally, and perhaps the easiest (therefore maybe the likeliest outcome) is to maintain Article 1105 with updates taken from the TPP draft. For instance, Article 9.6.4 setting out that ‘the mere fact that a Party takes or fails to take an action that may be inconsistent with an investor’s expectations does not constitute a breach of this Article, even if there is loss or damage to the covered investment as a result.’ Or the attempt to safeguard policy space in Article 9.16.

I welcome your thoughts.

* Thanks to Federico Ortino, Todd Tucker, and Simon Lester for feedback on the post.

** Todd Tucker proposed removing compensation rights from FET.