May 1, 2015

In my last column (“The Environmental Struggle Within the Trans-Pacific Partnership,” Jan. 8, 2015), I discussed the failure of the proposed Trans-Pacific Partnership (TPP) trade agreement to include sufficiently strong requirements for the parties (the U.S. and 11 other Pacific rim countries from Asia and the Americas) to comply with multilateral environmental agreements, resolve environmental disputes, protect fisheries and endangered species, address climate change and require responsible corporate conduct affecting the environment. On March 25, 2015, WikiLeaks also released the confidential draft “Investor Protection” chapter of the TPP, which raises a very different series of environmental issues.

Rather than encouraging effective environmental regulation by TPP Parties, the Investor Protection chapter as presently drafted could chill such regulation because of the threat of expropriation and other damage claims by affected “investors” from other TPP Parties. In addition, there remain significant policy issues concerning the mandatory arbitration procedures for resolving environmental disputes between those investors and TPP Parties.

This would repeat, with broader consequences, the same problem that arose under the investor protection provisions of Chapter 11 of the North American Free Trade Agreement (NAFTA). In NAFTA, similar, though less developed, investor protection provisions made it more difficult for Mexico, Canada and even the United States to enforce new environmental regulations against foreign investors who claimed that such regulations amounted to compensable takings or “inequitable treatment” under NAFTA.

Although Michael Froman, the U.S. Trade Representative (USTR), has attempted to cure some of these problems with more nuanced drafting than in NAFTA, the TPP language creates its own problems and provides plausible reasons for TPP Parties to avoid serious environmental regulation that could adversely affect transnational corporations. Moreover, the growing use of private arbitration to supplant domestic courts where foreign investors are involved raises important policy issues for the rule of law in many developing countries.

Categories

Aside from the issue of mandatory arbitration, the principal environmental issues posed by the TPP’s investment chapter fall into three broad categories: (1) environmental protection measures by Parties; (2) “fair and equitable” treatment for investors; and (3) indirect expropriation. In each of these areas, the possibilities for conflict are multiplied by the very broad definition of a protected “investor,” which appears to include virtually all transnational corporations, whether or not based in a TPP Party.

Environmental Protection Measures. Article II.15 of the investment chapter provides, in its entirety, that “Nothing in this Chapter shall be construed to prevent a Party from adopting, maintaining, or enforcing any measure otherwise consistent with this Chapter that it considers appropriate to ensure that investment activity in its territory is undertaken in a manner sensitive to environmental, health, or other regulatory objectives.” (emphasis added) In short, this ostensibly protective clause merely requires that any environmental measures undertaken by a party must be consistent with the balance of the investment chapter, making it all but meaningless. Moreover, even this protective rhetoric assumes that the activity in question may “be undertaken in a manner sensitive” to environmental concerns, rather than banned outright by local regulation.

Fair and Equitable Treatment for Investors. Article II.6 provides that each Party must treat all covered investments in accordance with customary international law, “including fair and equitable treatment.” In order to provide a bit of clarity to this obligation, Article II.6(2)(a) explains that fair and equitable treatment “includes the obligation not to deny justice in criminal, civil, or administrative adjudicatory proceedings in accordance with the principle of due process embodied in the principal legal systems of the world.” It is hard to imagine a more ambiguous phrase, or a more inviting opportunity to litigate endlessly, when assessing the consistency of challenged environmental regulations in a dozen different TPP countries.

Indirect Expropriation. Article II.7 of the investment chapter bars Parties from expropriating or nationalizing covered investments “either directly or indirectly through measures equivalent to expropriation of nationalization” except where such action is (a) for a public purpose; (b) non-discriminatory; (c) accompanied by prompt and fully realizable compensation; and (d) in accordance with due process of law. Recognizing that this obligation is at the heart of many investor disputes under NAFTA and otherwise, the draft chapter includes a special Annex II-B to elucidate the parties’ understanding of what constitutes an “indirect” expropriation.

Section 3(a) of that Annex provides that this requires a case-by-case, fact-based inquiry that considers, among other things, (i) the economic impact of the challenged action on the investor; (ii) the extent to which the action interferes with “distinct, reasonable investment-backed expectations”; and (iii) the character of the challenged action. Section 3(b) then provides a catch-all safety net of sorts for environmental and related regulations. That section provides that “Non-discriminatory regulatory actions…that are designed and applied to protect legitimate public welfare objectives, such as public health, safety and environment, do not constitute indirect expropriations, except in rare circumstances.”

These provisions were likely intended by the USTR to provide an enhanced level of protection for environmental regulations against the “takings” claims that have been rife under NAFTA. Yet, whatever the intention, the draft language leaves open significant opportunities for disgruntled investors to challenge local environmental regulations on a variety of grounds. Assuming a party’s new environmental measures qualify as advancing a “public purpose,” they must still qualify as “non-discriminatory,” both as “designed and applied to protect legitimate public welfare objectives, such as …the environment.” Even then, there could be “rare circumstances” in which such measures might be held to constitute indirect expropriations by an arbitral tribunal.

For example, would a party’s environmental regulations that imposed more stringent emission standards (or higher penalties) on large transnational corporations than on smaller domestic concerns be deemed “discriminatory?” After all, U.S. domestic law often distinguishes between large and small emitters of air pollutants. And who is to decide whether a “public welfare objective” is “legitimate” in the first place? Would the U.S. “Superfund” law, with its draconian remedy of retroactive joint and several no-fault liability for disposal of hazardous substances be “legitimate” or consistent with “reasonable investment-backed expectations,” as required by Annex II-B?

Suppose that a party wished to implement through regulation the Guidelines for Multinational Enterprises that were promulgated in 2011 by the Organization for Economic Cooperation and Development (OECD). Those guidelines not only call on transnational corporations to incorporate environmental (as well as labor, consumer and human rights) standards into their daily conduct but encourage (and arguably require) all OECD countries, including the United States, to implement those guidelines as part of their domestic laws. Article II.16 of the TPP investment chapter reaffirms the “importance of each Party encouraging enterprises…to voluntarily incorporate” corporate responsibility principles such as the OECD Guidelines. Does this mean that a party’s attempt to mandate compliance with the OECD Guidelines would not be “legitimate” under Annex II-B?

Investor Challenges

In view of these significant ambiguities in the draft TPP investment chapter, it is important to ask how likely TPP investors are to challenge either newly enacted or newly applied environmental regulations that adversely affect their business operations. For answers, we need only look at the scorched-earth litigation tactics currently being employed in the U.S. courts by corporations subject to new climate change and related emission limits from the Environmental Protection Agency. However, unlike most TPP Parties, the U.S. Department of Justice has both the resources and the will to resist such challenges, whether under domestic law or in international arbitration under NAFTA’s Chapter 11. As a result, virtually all NAFTA arbitration claims challenging U.S. environmental regulation have been dismissed. In my view, there is little risk that future claims under the TPP would either encourage or chill future U.S. environmental regulation or enforcement, which is far more likely to be affected by domestic interests than by the fear of arbitration claims under the TPP.

That has not been the case, however, for Mexico and Canada under NAFTA. In the last five years, NAFTA arbitrators have decided at least seven Chapter 11 claims alleging that Canadian actions (whether federal or provincial) amounted to indirect expropriation or inequitable treatment, and another eight such claims are currently pending. Mexico has been subject to fewer claims under Chapter 11, but it has on at least two occasions been found liable to U.S. investors because of environmental or public health actions of its federal or provincial governments. (For a review of the early history of Chapter 11 arbitration awards under NAFTA, see “NAFTA’S Chapter 11 and U.S. Trade Agreements,” NYLJ June 27, 2008 and “NAFTA’s Chapter 11: Regulatory Takings Revisited,” Sept. 11, 2000.)

Despite the efforts of the USTR to reduce the risk of such awards under the TPP, the prospect of multimillion-dollar damage awards (and costly multi-year litigation) in favor of aggrieved foreign investors will inevitably affect how TPP Parties assess the risks and benefits of their environmental regulation and enforcement policies. In view of the real ambiguities in the TPP provisions discussed above and the resources and zeal that affected TPP investors can bring to such disputes, it will be difficult for even environmentally motivated TPP Parties to dismiss such risks as insignificant.

Mandatory Arbitration

Like NAFTA and virtually all subsequent U.S. trade agreements, Articles II.18-23 of the TPP investment chapter provides for mandatory arbitration, under either the Convention on the Settlement of Investment Disputes Between States and Nationals of Other States (ICSID) or the arbitration rules of the U.N. Commission on International Trade Law (UNCITRAL), of investor claims against a TPP Party. The draft chapter includes a number of improvements over some earlier agreements, including making most written submissions to the arbitrators available to the public, holding public hearings (with exceptions for confidential information) and authorizing the arbitral panel, in its discretion, to accept amicus curiae briefs.

Although the arbitrators are, in general, to decide claims on the basis of the TPP provisions and applicable international law, questions as to whether challenged government actions, including environmental measures, amount to an expropriation under Annex II are to be decided by the newly established TPP Commission rather than by the arbitrators. While these provisions are welcome, they simply do not go far enough to assure publicly accessible hearings or participation by citizen groups in defending domestic environmental regulations that the TPP Party itself may have little interest or ability to defend.

More fundamentally, the mandatory arbitration scheme, which is at the heart of many U.S. trade agreements, needs to be reconsidered. It is certainly in the interest of many transnational corporations to be able to adjudicate expropriation and other claims against host governments in private arbitration proceedings in New York, the Hague or even a nation’s capital, but there is a real cost—and lost opportunity—from this privatized justice in terms of effective and independent judiciaries in developing countries. It would be far preferable, as well as more respectful of national sovereignty, to establish specialized panels within domestic courts to adjudicate such claims, just as the United States did when it created federal courts with diversity jurisdiction or as the State of New York has done with its Supreme Court Commercial Division.

In the long run, the development of the rule of law in developing countries and emerging economies is of greater interest to the United States than advancing the litigation claims of its transnational companies, many of which are not even based in the U.S. If a TPP Party wishes to agree to arbitrate claims by foreign investors, it can certainly do that, either within the terms of the TPP or through separate agreements with its investors. However, the TPP should not foreclose this option and should, in my view, make its entire arbitration scheme optional.

Conclusion

The combination of (1) the TPP’s relatively weak environmental requirements discussed in my Jan. 8 column and (2) the ample opportunities for foreign investors to seek damages for economic injury from any environmental regulations that a TPP Party does impose are likely to discourage meaningful environmental regulation of transnational corporations in many TPP countries. While this may benefit some U.S. investors and companies in the short term, the long-term U.S. interest in a healthy global environment is at least as important as an efficient global marketplace. The TPP should therefore be revised to recognize this priority both in its environmental requirements and in the protection it demands for investors from its TPP partners.