Sold Down the Yangtze: Extended note for chapter 34

In Chapter 34 of my book Sold Down the Yangtze: Canada’s Lopsided Investment Deal with China, I said that I’d post on this blog an outline of the Canada-China FIPA’s complex loophole on most-favoured-nation (MFN) treatment and how this loophole undermines the FIPA’s moderating language in other areas.

The FIPA has provisions that appear to safeguard the regulatory interests of countries. In particular, language in Article 4(2) and (3) and Annex B.10 of the FIPA would likely constrain some of the arbitrators’ far-reaching interpretations of concepts of fair and equitable treatment, full protection and security, and indirect expropriation. For Canada, this moderating language dates from 2001 when the NAFTA countries issued a statement of interpretation to rein in NAFTA ISDS tribunals. After that, Canada used the language in its subsequent treaties.

These provisions in the FIPA were often highlighted by its promoters to reassure the public about the deal’s risks for governments and legislatures. Yet, the provisions are open to serious doubt, due to the FIPA’s complex loophole and “reach-back” on MFN treatment.

Based on their MFN treatment obligations, Canada and China must give no less favourable treatment to foreign investors from the other country as compared to the treatment given in like circumstances to foreign investors from third countries. More simply, MFN treatment is a “me too” clause. As such, the point of comparison for MFN treatment is the host country’s treatment of third-country investors. In this respect, the FIPA’s MFN provision is unremarkable.

More significantly, the FIPA extends its MFN treatment obligation beyond any treatment that is given to third-country investors in future treaties to include treatment given in previous treaties of Canada or China since 1994. This approach differs from all but a few FIPAs concluded by Canada, in that it makes clear that MFN treatment extends to treatment afforded to third-country investors in past FIPAs. Other treaties concluded by Canada either preclude expressly, or are silent on, the application of MFN treatment to previous treaties.

This express “reach-back” in the China FIPA also differs from Canada’s Model FIPA, which says that MFN treatment “shall not apply to treatment under all bilateral or multilateral international agreements in force or signed prior to the date of entry into force of this Agreement.” Thus, while Canada’s Model FIPA makes clear that MFN treatment does not allow foreign investors to mix and match provisions from previous treaties as a creative legal strategy, the China FIPA makes clear that they can.

For present purposes, the significance of this reach-back on MFN treatment is that it puts the China FIPA’s moderating provisions, highlighted earlier, at serious risk. Perhaps most significant is the risk to the FIPA’s moderating language on fair and equitable treatment and full protection and security, given the extent to which ISDS tribunals have interpreted these concepts expansively in favour of claimant investors. To elaborate, the FIPA’s moderating provisions appear to restrict such expansive interpretations, by clarifying in Article 4 that the concepts in question “do not require treatment in addition to or beyond that which is required by the international law minimum standard of treatment of aliens as evidenced by State practice accepted as law.” In other words, the FIPA affirms that the concepts are limited to their customary meaning, based on the usual evidentiary requirements of customary international law, and thus guards against arbitrators introducing novel obligations as part of the general obligations to provide fair and equitable treatment or full protection and security.

Similarly, on indirect expropriation, Annex B.10 of the FIPA provides, among other things:

Except in rare circumstances, such as if a measure or series of measures is so severe in light of its purpose that it cannot be reasonably viewed as having been adopted and applied in good faith, a non-discriminatory measure or series of measures of a Contracting Party that is designed and applied to protect the legitimate public objectives for the well-being of citizens, such as health, safety and the environment, does not constitute indirect expropriation.

This provision likewise responds to expansive approaches by ISDS arbitrators in, for example, the early NAFTA award in Metalclad v Mexico, where the tribunal adopted a far-reaching approach to indirect expropriation.

It is unclear how ISDS tribunals under the China FIPA would respond to these moderating provisions, given the prevalence of expansive approaches. But the moderating language is at least an important factor weighing against expansive interpretations that may frustrate democratic and regulatory decisions in Canada or China.

However, critically, the FIPA’s reach-back on MFN treatment casts serious doubt on the effectiveness of these moderating provisions. The serious doubt arises because both Canada and China have concluded treaties since 1994 that do not incorporate the moderating provisions and, as a result, have assumed a significant risk of being unable to rely on the FIPA’s moderating provisions due to their obligation to provide MFN treatment. In Canada’s case, therefore, a Chinese investor would be able to argue that it is entitled to no less favourable treatment than that enjoyed by third-country investors under any of Canada’s fourteen post-1994 FIPAs in which fair and equitable treatment, full protection and security, and indirect expropriation are not subject to the moderating provisions.

For various reasons, it is at least likely that an ISDS tribunal would decide that the FIPA’s moderating provisions amount to less favourable treatment, compared to the treatment of third-country investors under Canada’s other FIPAs. First, MFN treatment has been interpreted broadly—in that it has been extended to treatment relating to dispute settlement provisions rather than simply to substantive provisions in other treaties—by about half of the twenty ISDS tribunals that faced and resolved this issue in a publicly available award up to the spring of 2010.[2] Second, even if a tribunal under the FIPA took a more restrictive approach, by limiting MFN treatment to substantive provisions only, the FIPA’s moderating provisions would still be in jeopardy because they involve the FIPA’s substantive, rather than its dispute settlement, provisions.

To illustrate, in Paushok v Mongolia, an ISDS tribunal adopted a relatively restrictive (that is, country-friendly) approach to MFN treatment, by declining to extend the concept of MFN treatment to treatment in dispute settlement provisions or to treatment in entirely new substantive provision in other treaties. According to the tribunal at paragraphs 565 and 570 of its decision:

[h]istorically, tribunals have tended to construe MFN clauses broadly and they have regularly accepted to import substantive rights into an investment treaty from treaties that the host State has signed with other countries. This broad interpretation has also led tribunals to allow the import of more favorable procedural rights. There are however other cases which have adopted a more restrictive interpretation concerning the import of procedural rights but this issue need not be addressed in the present case, the question relating simply to the import of substantive rights.

…. The treaty is quite clear as to the interpretation to be given to the MFN clause … the extension of substantive rights it allows only has to do with Article 3(1) which deals with fair and equitable treatment. If there exists any other BIT between Mongolia and another State which provides for a more generous provision relating to fair and equitable treatment, an investor under the Treaty is entitled to invoke it. But, such investor cannot use that MFN clause to introduce into the Treaty completely new substantive rights, such as those granted under an umbrella clause.

Based on this approach and on the terms of the relevant BIT, the concept of MFN treatment was extended by the Paushok tribunal to substantive rights only in situations where a more generous version of the same substantive right had been included in the treaty with a third country.

Yet, even on this restrictive approach, foreign investors under the China FIPA would be relieved of its moderating provisions relating to fair and equitable treatment, full protection and security, and indirect expropriation because each of these concepts is part of a more generous version of the same substantive provisions in other FIPAs that do not have the moderating provisions.

Further, if an ISDS tribunal under the FIPA took an approach going beyond Paushok, as is common in other ISDS awards, the tribunal could incorporate other provisions from other FIPAS in order to expand investor protection. In this way, the reach-back on MFN treatment undermines a variety of moderating provisions in the FIPA.

Incidentally, it appears that the federal government itself determined, as part of its negotiating strategy for the China FIPA, to jeopardize Canada’s post-2001 moderating provisions in this way, for the purpose of obtaining for Canadian investors a similar ability to avoid the FIPA’s moderating provisions in ISDS claims against China. When questioned under oath about the FIPA’s reach-back on MFN treatment, federal trade official Vernon MacKay stated at pages 51-53:

China has over a hundred of what we call bilateral investment treaties very similar to [FIPAs]. Most of them we would not want access to because they’re not high-ambition — what we would call a high-ambition treaty. But there were a few in the early 2000s with some European countries that are pretty high standard. They’re not directly comparable, so it’s hard to say, you know, just how much more advantageous they might be to an investor, but they were — they were ones that we were considering …

The fair and equitable standards of some of these treaties are very broadly worded, certainly worded in ways that we would not word ours, which could lend themselves to an expansive interpretation which our Canadian investors may take advantage of in a Chinese market situation …

[S]ome of these provisions were potentially more of a broader scope and could provide high — you know, more protection for a Canadian investor. So since — and just to clarify, the Canadian model, as we have included in here, does not include that reach-back to 1994, but it is — we have the policy flexibility, if I could say that, to modify that … We use that 1994 reach-back as an incentive to get the other party to reach back as well.

This testimony indicates that Canadian negotiators intended the reach-back on MFN treatment to expand the benefits of the FIPA for foreign investors at the expense of democratic and regulatory interests. In turn, it was dubious, based on the existing record of ISDS arbitration and McKay’s testimony, for anyone to rely on the FIPA’s moderating provisions as a safeguard for democracy and regulation.