COVID-19 and investment claims under NAFTA

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COVID-19 Alert

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We recently published two articles examining the potential for investment claims arising out of measures taken by States in response to the coronavirus disease 2019 (COVID-19) pandemic. The first (COVID-19 – a legitimate basis for investment claims?) looked at whether such measures could provide a legitimate basis for claims under bilateral investment treaties (BITs) or other investment protection agreements. The second (State defenses to investment claims arising from COVID-19) addressed some of the key defenses available to States under customary international law. In this article, the third in our series, we focus on whether measures taken by States in response to the pandemic could provide a basis for claims under the North American Free Trade Agreement (NAFTA),[1] identify some of the specific defenses that may be available to the State parties to NAFTA, and outline key factors that investors are urged to take into account when deciding whether to bring claims under NAFTA or its successor instrument, the Agreement between the United States of America, the United Mexican States, and Canada (USMCA).[2]

Overview

Much like other States around the globe, the US, Canada and Mexico have taken emergency measures in response to the COVID-19 pandemic. Such measures range from social distancing requirements and restrictions on travel to the mandatory closure of businesses. We have already witnessed certain examples of the types of measures that might give rise to claims.

In the US, for example, the federal government has invoked the Defense Protection Act (DPA), forcing certain companies to manufacture ventilators to treat patients suffering from COVID-19 (our prior alert on the President’s invocation of the DPA can be found here). Invoking similar authority, the Administration has also sought to halt exports of certain personal protective equipment manufactured in the US to other countries, including Canada, so as to ensure a sufficient supply in the US. And the Committee on Foreign Investment in the United States − the inter-agency committee authorized to review certain transactions involving foreign investment in the US to determine possible effects on national security − may now increasingly limit foreign investments in the health and pharmaceutical sectors, as well as those that may threaten supply chain security (our prior alert on expanded global foreign direct investment reviews can be found here). Markedly, in other contexts, this same review process has resulted in the forced divestiture of two US businesses that had been acquired by foreign (Chinese) entities. Finally, the US government has made certain loan programs available under the Coronavirus Aid, Relief and Economic Security Act (CARES Act); however, questions remain as to whether borrower eligibility requirements might be interpreted so as to discriminate against US subsidiaries or affiliates of foreign-owned companies as compared to their US counterparts.

In Canada, the federal government has taken legislative steps to amend prior statutes thereby allowing it to apply to the Commissioner of Patents for authorization, on behalf of itself or a third party, to make, construct, use and sell a patented invention, to the extent necessary to respond to a public health emergency such as COVID-19.[3] While the transfer of rights is limited in duration, and the amendment otherwise requires compensation to patent holders, it remains to be seen how the provision will be implemented in practice. As in the example cited above, the Canadian government also has issued a new foreign direct investment policy which permits greater scrutiny over foreign investments related to public health or the supply of critical goods and services to Canadians or to the government (the specifics of the Canadian measures are also addressed in our alert on expanded global foreign direct investment reviews).

In Mexico, all businesses not engaging in “essential” activities have been closed through May 30, 2020. However, the illustrative list of “essential” activities in the relevant regulation leaves significant room for interpretation regarding how a particular business should be classified, and the extent to which businesses up and down the supply chain, or businesses which manufacture goods solely for export, qualify as engaging in essential activities.

This ambiguity has resulted in an inconsistent application of Mexico’s COVID-19 related measures and, in some parts of the country, assertions by State and local authorities that, where certain products are only manufactured for export and not for domestic use, those businesses are not considered “essential” to Mexico and are susceptible to shut down. There have also been examples of State government authorities purporting to require companies engaged in the manufacture of medical devices to sell a portion of their product to the government, potentially in breach of the manufacturer’s existing contractual obligations, as a condition to being considered an essential service, and thus permitted to continue operations. Mexico’s National Center for the Control of Energy has also announced measures which will have a significant negative impact on the renewable energy market in Mexico − measures which it says are justified by the COVID-19 pandemic.[4]

Canadian, Mexican, and US investors who have seen their investments in other NAFTA countries impacted by measures such as these, adopted as a result of COVID-19, will want to be aware of their rights under NAFTA and the USMCA, particularly now with the USMCA just months from coming into effect.

Investment protections under NAFTA

The measures taken by States globally to combat COVID-19 will no doubt form the basis of claims by investors, the merits of which will need to be evaluated on a case-by-case basis. Before bringing any claims under NAFTA, investors are urged to consider what protections might be available to them. The protection standards most commonly invoked by investors under NAFTA include:

  • The prohibition on expropriation without compensation (Article 1110) – The expropriation standard under NAFTA covers any outright requisition or nationalization of an investment. Equally, an enforced lockdown, or the classification of a business as “non-essential” resulting in its closure, or the “taking” of key rights associated with investments or property rights, could constitute an indirect expropriation to the extent that these measures cause the loss of control, or the failure of the business, or the loss of substantially all the business/investment’s value irrespective of whether or not the measures result in a physical taking.
  • The right to fair and equitable/minimum standard of treatment (Article 1105) – NAFTA tribunals have interpreted Article 1105 as only providing a minimum standard of treatment, given its express reference to “international law”.[5]Therefore, the State’s conduct must be “egregious” or “shocking” from an international perspective, and a simple illegality under domestic law will not suffice to establish a breach. However, given that customary international law develops over time to reflect State practice, there is some debate as to whether the minimum standard of treatment has evolved, such that nowadays there is no substantive difference between the two standards of treatment. Accordingly, under the NAFTA standard, investors may also be able to challenge some COVID-19 measures on the basis of their lack of proportionality, or on the basis that the measures have been implemented in an arbitrary or discriminatory manner.
  • The right to national (Article 1102) and most-favored-nation (Article 1103) treatment – Under NAFTA, State aid packages offered to domestic companies may constitute violations of the right to national and most-favored-nation treatment in circumstances where such packages create an uneven playing field as between foreign and domestic investors. Similarly, measures designed to assist a State-owned entity at the expense of privately-held interests in the same sector could give rise to claims that the State has failed to provide national treatment.

Likely defenses to claims brought under NAFTA

Even if an investor can establish that there has been a breach of an investment protection, State parties may nonetheless have one or more valid defenses to investment treaty claims. Such defenses may be established based on either (i) the specific wording of NAFTA or (ii) customary international law.

NAFTA defenses

As noted in our earlier article, investment treaties have tended to adopt a similar format, pursuant to which investors are granted rights and host-States have assumed obligations in respect of foreign investments. States commonly have little in the way of express defenses or exceptions set forth in the treaty itself.[6]

However, one example of an express defense can be found in Article 1108(7)(b) of NAFTA, which provides that the protections under Articles 1102 (national treatment) and 1103 (most-favored-nation treatment) do not apply to “subsidies or grants provided by a Party or a state enterprise, including government supported loans, guarantees and insurance.” Thus, State defendants to NAFTA claims may be able to rely on this exception in relation to allegations that their State aid packages fail to treat domestic and foreign investors equally.

Customary international law defenses

In the absence of specific language in an investment treaty, a State may nonetheless be able to invoke a range of defenses available under customary international law.

The International Law Commission’s Articles on Responsibility of States for Internationally Wrongful Acts (2001)[7] establish six defenses that States may invoke to avoid responsibility. Of the six available defenses, the most likely grounds to be invoked in relation to COVID-19 related claims are (i) force majeure (Article 23), (ii) distress (Article 24), and (iii) necessity (Article 25).

These defenses are discussed in greater detail in our second article in this series.

Availability of claims in light of the USMCA

As from July 1, 2020, the USMCA will enter into force, replacing NAFTA.[8]

The USMCA’s entry into force is significant for investors, as this new agreement substantially reduces the availability of certain types of investment claims that were previously available under Chapter 11 of NAFTA. In particular, certain of the investor claims which are likely to arise out of the COVID-19 pandemic may not be available under the more narrowly drafted USMCA. Thus, in deciding when to bring their claims, investors are encouraged to be mindful of the following.

Canada’s withdrawal from the investor-state arbitration mechanism

Under the USMCA, Canada will withdraw from the investor-State arbitration mechanism entirely. This means that, under this instrument, Canadian investors will no longer able to bring investment arbitration claims against Mexico or the US. Similarly, US or Mexican investors will no longer have the right to bring investment arbitration claims against Canada under the USMCA; rather, they will have to bring such claims under another investment agreement or litigate them before the Canadian courts. Of course, Canadian investors with investments in Mexico, and Mexican investors with investments in Canada, will still benefit from the ability to bring investment claims under the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which is in force in both countries. However, for US investors in Canada, or Canadian investors in the US, litigation before local courts will be the only option.

Different grounds for investment claims available to investors

As between Mexico and the US, the USMCA retains an investor-State dispute settlement mechanism, but distinguishes between “Annex 14-D” and “Annex 14-E” investors, with different grounds for investment claims available to each group.

  • Only “Annex 14-E” investors, being those with “covered government contracts” (meaning they have contracted with a national authority) in “covered sectors” (for example, oil and gas, and the provision of telecommunications, transportation and infrastructure services direct to the public), retain the ability to bring investment claims for breaches of all of the standards of protection set forth in the main body of Chapter 14 (which is the equivalent of Chapter 11 in NAFTA), including claims for indirect expropriation or breach of the fair and equitable/minimum standards of treatment.
  • In contrast, “Annex 14-D” investors, being investors without a “covered government contract” in a “covered sector,” may only bring investment claims for breaches of the national treatment, most-favored-nation treatment, and direct expropriation standards. Claims for indirect expropriation or breach of the fair and equitable/minimum standards of treatment are expressly excluded for this category of investors. Significantly, these are the two most commonly relied-upon protections in investor-State claims.

Therefore, upon entry into force of the USMCA, these “Annex 14-D” investors will lose a significant tranche of claims that might have been available to them under NAFTA. Further, the USMCA requires that “Annex 14-D” investors exhaust local remedies for a period of 30 months as a precondition to bringing international arbitration claims against the host-State.[9]

Additional defense to indirect expropriation claims

Finally, investors should be aware that the USMCA provides the US and Mexico with an explicit defense to claims for indirect expropriation where the challenged measures were adopted to protect the public health. To that end, the USMCA provides:

Non-discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives, such as health, safety and the environment, do not constitute indirect expropriations, except in rare circumstances. (Annex 14-B Expropriation, para. 3(b))

This language is significant because it means that even those investors with a “covered government contract” in a “covered sector,” who otherwise retain similar substantive grounds for asserting investment claims to those provided under NAFTA, may still face additional hurdles when advancing COVID-19 related claims under the USMCA. Certainly, the argument that a non-discriminatory measure adopted in pursuit of legitimate public welfare objectives does not constitute a breach of international law might be available anyway, under customary international law. However, by including this express language in the USMCA, Mexico and the US have given States a stronger basis for asserting this defense.

The access to investor-State arbitration offered to investors by the USMCA is significantly diluted compared to the regime available under NAFTA. Therefore, investors with potential claims are encouraged to start thinking now as to whether they should be asserting claims under NAFTA before they lose their rights. Investors have three years from July 1, 2020 to bring claims under NAFTA provided that the investment concerned was established or acquired while NAFTA was in force (between January 1, 1994 and July 1, 2020), and that the investment remains in force as at July 1, 2020. Ongoing investment claims will not be affected by the entry into force of the USMCA.

If you have any questions regarding these issues and their implications, please contact the authors or your DLA Piper relationship attorney.

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This information does not, and is not intended to, constitute legal advice. All information, content, and materials are for general informational purposes only. No reader should act, or refrain from acting, with respect to any particular legal matter on the basis of this information without first seeking legal advice from counsel in the relevant jurisdiction.


[1]  North American Trade Agreement Free Trade Agreement, dated 1 January 1994.

[2]  Agreement between the United States of America, the United Mexican States, and Canada, signed on 13 December 2019 (not yet in force).

[3]  COVID-19 Emergency Response Act, S.C. 2020, c. 5, § 51 (Can.).

[4]  This measure, which affects the renewable energy industry in Mexico, will be the subject of a forthcoming article.

[5]  See also Notes of Interpretation of Certain Chapter 11 Provisions (NAFTA Free Trade Commission, July 31, 2001).

[6]  In recent years, new investment treaties have started to include provisions that have sought to address this perceived imbalance between the rights afforded to investors and the obligations placed on host-States. The USMCA, but not NAFTA, contains some of these types of provisions. See, e.g., USMCA, Annex 14-B Expropriation, para. 3(b), discussed below.

[7]  UN General Assembly, Responsibility of States for internationally wrongful acts : resolution / adopted by the General Assembly, 8 January 2008, A/RES/62/61.

[8]  See USMCA Protocol, Article 2.

[9]  By contrast, NAFTA does not require investors to exhaust local remedies and only contains a six-month “cooling off period.”