Federal lawyers were in an Ottawa courtroom on Monday seeking to quash a potentially costly, Nova Scotia-linked NAFTA tribunal ruling that is seen by some as a test of sovereignty under the free trade agreement.

The Delaware-based Bilcon is seeking more than $500 million in compensation after an international arbitration panel ruled in 2015 the American company was wrongly denied permission to open a 152-hectare quarry and marine terminal on Digby Neck, N.S.

The long peninsula on the Bay of Fundy — home to about 2,000 people — was chosen by Bilcon as the future site of a 50-year stone quarry in 2002, only to have its proposal rejected by a joint federal-provincial review panel in 2008 due to environmental concerns.

Bilcon successfully sued Canada using a controversial investor protections clause found under Chapter 11 of the North American Free Trade Agreement, which allows foreign companies to sue governments over unfair treatment.

"This outcome, this exposure to potential damages, is outside the scope of the NAFTA agreement," Canada lawyer Roger Flaim argued in the Federal Court of Canada on Monday.

Overstepping authority

Flaim said the international arbitration tribunal overstepped its authority in ruling Canada's rejection of the quarry was so egregious it was liable for damages under Chapter 11.

Bilcon had claimed it was blindsided by the joint panel's decision to reject its proposal, and convinced the tribunal its treatment was unfair, arbitrary and unprecedented.

Canada's lawyer Roger Flaim argued in Federal Court Monday that a NAFTA arbitration ruling in the Bilcon case should be set aside. (Paul Withers/CBC)

In court Monday, federal lawyers argued that the tribunal did not have the jurisdiction to decide on the Canadian environment assessment process. The remedy, the lawyers said, was to seek a judicial review in this country.

"At the end of the day, the liability was arrived at for the same reasons the decision would have been set aside on judicial review," Flaim said.

Monday's hearing comes just three weeks before Bilcon goes back to the same arbitration tribunal to complete the second phase of the case — settling on the award for damages.

"In three weeks, Canada will be defending itself from damages in excess of $500 million in respect to questions that should be answered by this court," Flaim said.

Environmental laws, foreign investors

According to University of Ottawa law professor Amir Attaran, the case is important test of sovereignty because what's at stake is whether Canada has the right to enforce its own environmental laws on foreign investors.

"In this case, what's happened was an American concrete company wanted to carry out a project that will affect the environment terribly, including whale-breeding habitat," said Attaran, who is also a lawyer for Ecojustice Law, which is representing two environmental groups who are intervenors in the case.

"When they were told no by the Canadian and Nova Scotia governments, they demanded a half-a-billion-dollar payout for not getting permission to carry out their project."

Bilcon lawyers head into Federal Court on Monday. Gregory Nash (right) is the lead lawyer for the American company. (Paul Withers/CBC)

NAFTA Chapter 11 problems

Investor protections outlined under NAFTA's Chapter 11 are a problem, said Catherine Abreu, of the East Coast Environmental Law Association, an intervenor in the case.

"Ultimately Chapter 11 is hurting Canada and Canadians rather than helping us and our private businesses," she said.

Both Abreu and Attaran questioned why Ottawa is supporting the current dispute-resolution mechanism under NAFTA, which has frequently found Canada liable for compensation.

Amir Attaran says what's at stake in the case is whether Canada has the right to enforce its own environmental laws on foreign investors. (Adrian Wyld/Canadian Press)

"Why is the Trudeau government hanging on to keep a NAFTA investments system which has cost us money, which we lose in. And it's the Americans who are always winning who want to get rid of it. This makes no sense," said Attaran.

The Trump administration has said it wants the right to opt out of the binding dispute-resolution panels of Chapter 11, because it views them as an invasion of sovereignty and an incentive for companies to outsource to Mexico.

Canada's Foreign Affairs Minister Chrystia Freeland has called for reforms to Chapter 11 so that "governments have an unassailable right to regulate in the public interest."

The quarry case resumes Tuesday, when Bilcon lawyers are expected to argue that way the project was rejected was so arbitrary that it deserved protections under NAFTA.

The company also disputes that a precedent could be established in the case.