By Katherine Ruta
Canadian water security is being threatened in two ways. First, the North American Free Trade Agreement (NAFTA) and the General Agreement on Tariffs and Trade contain a general restriction on prohibiting exports. Water may be covered by these provisions. If so, a prohibition on the export of fresh water would be challengeable under these agreements. In response to this ambiguity, the Canadian government has stopped short of an outright prohibition on the bulk export of fresh water.
Water security is also threatened indirectly by foreign-owned companies who have investor rights under trade agreements. Investor provisions allow foreign-owned companies to challenge government decisions that affect their investment.
While this article will only concern itself with NAFTA, the lessons around the penetrability of investor provisions in domestic decision-making are widely applicable to other international trade agreements.
Canada’s “abundance of water” is a myth
According to Canadian media, Canada has more fresh water than any other country on earth. Throughout the 80s, 90s, and early 2000s, reputable Canadian publications and environmental organizations have claimed that Canada has anywhere from 25 to 40% of the global supply of fresh water, or one-fifth of the global water supply.
This myth has stemmed largely from the misunderstanding about the significance of volume of water versus renewable supply. The volume of water refers to all water sitting in lakes, rivers, aquifers and glaciers, whereas renewable supply refers to the amount of water that is replenished every year by the natural hydrological cycle. In terms of water management, the amount of renewable fresh water is the key concern, because overdrawing on non-renewable sources will inevitably lead to a depletion of fresh water.
Canada indeed has a volume of fresh water that accounts for 20% of the earth’s fresh water. However, almost 60% of this flows north to the Arctic or Subarctic and is largely unusable. The water supply found in southern Canada accounts for about 2.6% of the world’s supply of fresh water. In terms of renewable water, Canada has 6.5% of the world’s renewable water resources; however, this includes water that is inaccessible. This ranks Canada third behind Brazil which has 12.4%, and the Russian Federation which has 10% of the world’s renewable water supply.
Consequently, the amount of accessible fresh water that replenishes itself every year is far below the general perception of how much fresh water Canada has available for use. In fact, current production levels in the Alberta oil sands are unsustainable because of the growing unavailability of water necessary for the production process.
The question surrounding investor provisions in NAFTA is whether, for scarcity or any other reason, the Canadian government will be able to scale back or impose a rigorous water management scheme, without facing hefty financial penalties or other consequences for impacting investors.
NAFTA Chapter 11
An investor-to-state resolution mechanism is provided under NAFTA Chapter 11 and allows investors to sue governments directly for any breach of the provisions. Any “measure” by a government relating to investors may be challenged under this Chapter. Generally speaking, these provisions impose a binding obligation on the Canadian government to extend the same treatment to U.S. or Mexican-owned (foreign-owned) companies as Canadian companies. Any opportunity for rights, licenses, or permissions granted to a corporation for the removal or diversion of water must be extended to foreign-owned companies as well.
However, more importantly, the provisions also protect investors against measures taken by the Canadian government that result in an investment being compromised in any way. Courts and panels have interpreted these provisions broadly and this will have application to domestic water management.
The first thing to note is the breadth of claimants who are considered investors. Article 1101 states that the provisions apply to all “investors” and “investments of investors.” A panel found that a corporation qualified as an investor even though it was unclear whether the corporation in question had assets in Canada. The same company also succeeded in arguing that an investment includes a portion of market share. This definition of investor is very flexible, which suggests Canadian governments must take into consideration an amorphous group of foreign companies when making decisions.
Further contributing to this difficulty is what has been found to constitute a “measure.” A measure was held to include “any law, regulation, procedure, requirement, or practice.” In Ethyl Corporation v. Canada, a court went so far as to hold that an un-adopted bill in Parliament was a measure that could be challenged under the investment provisions. The bill proposed to ban the import of methylcylopentadienyl manganese tricarbonyl (MMT), a fuel additive. Canada was in the process of attempting to restrict its trade because of its dangerous effects. MMT was already illegal in some U.S. states.
The court allowed Ethyl Corporation to challenge the proposed bill. Ethyl argued that the proposed MMT ban would reduce the value of their MMT manufacturing plant, thereby violating the expropriation provisions in Article 1110 that prohibit the direct or indirect nationalization or expropriation of investments. The court rejected Canada’s argument that the measure was not an investment matter. Canada settled with Ethyl for $11 million.
This case sent a signal to government decision-makers that little attention will be paid, or deference given, to the primary objective of government action when deciding whether it violates investor rights. Subsequently, “measure” has also been interpreted to include jury decisions, and decisions of a Supreme Court.
Even where market share was the alleged investment, Canada’s export ban on PCBs, consistent with its international obligations, was found to violate national treatment provisions in Chapter 11. While the panel recognized the ban as a legitimate measure to meet Canada’s international commitments, it found that it had an adverse effect on the market share of foreign investors. The Canadian government, it seems, must take account of investors when passing or amending laws that have incidental effects on the investment of foreign-owned companies.This is not the only way investor rights have penetrated domestic decision making.
Minimum treatment provisions ensure that investors are accorded the same protections as domestic investors, and that measures are not applied to them in a discriminatory manner. Minimum treatment goes well beyond that now. In Metalclad v. Municipality of Guadalcazar, Metalclad was successful in bringing a claim pursuant to the minimum treatment and expropriation provisions when their municipal construction permit got rejected by Mexican authorities.
Prior to their investment, the Mexican federal government assured Metalclad that their hazardous waste facility had all the required permits. The municipal government, in response to local opposition to the waste facility, attempted to exercise its jurisdiction with respect to the creation of, and maintenance of, ecological zones, to deny Metalclad a municipal construction permit. As a preliminary matter, the panel made a determination on a point of Mexican domestic law on the scope of municipal authority in granting permits. This interpretation was contrary to those presented by Mexican legal experts and stands as a troubling precedent.
Next, the panel decided that federal support of the project was misleading and violated minimum treatment provisions because the government failed to provide a transparent and predictable framework for investment. The result is that local opposition to foreign-owned projects can be the subject of an investor challenge. This suggests that municipalities have a limited ability to exercise their jurisdiction to oppose foreign-owned projects that have received support from a federal government.
If Canada’s federal government pursues and supports business opportunities that involve water-taking, but these projects do not meet requirements at the provincial or municipal level due to local land-use or environmental laws or by-laws, investor rights may supersede a legitimate exercise of provincial or municipal jurisdiction.
A few years ago, Sun Belt commenced a Chapter 11 proceeding against the British Columbia government when their license to export water from the province was blocked by a provincial moratorium on bulk water. The moratorium was in response to public opposition to the project. The case never proceeded through the NAFTA dispute settlement system because the government settled with Sun Belt. Given the broad interpretations given to Chapter 11 provisions it seems likely Sun Belt would have been successful.
The overall effect of these decisions is that governments and courts will have difficulty making decisions on water licensing schemes with water management or environmental objectives, without having to compensate investors.
Most provinces have legislation that regulates water-takings. In Ontario, the Water Resources Act requires a permit to take more than 50,000 litres a day from ground or surface water sources. A cursory review of the legislation reveals that it is not a sophisticated scheme. Any changes to permits or their requirements that have been granted to foreign-owned corporations could be challenged.
Regardless of government objectives, investor rights under NAFTA are broad enough to penetrate these domestic decisions where they have an adverse affect on investments or market share.
Nestlé currently has a permit that allows a draw of 1.13 million litres of groundwater per day in Wellington County, Ontario, at a rate of only $3.71 for each million litres. In the fall of 2012, Nestlé appealed a decision by the Ontario Ministry of Environment to place restrictions on their permit in a time of drought. Nestlé withdrew its appeal when the Ministry agreed to exempt their permit from the restrictions.
When the settlement was challenged by community groups, it was rejected by the Ontario Environmental Review Tribunal who decided that Nestlé’s appeal should be subject to a full hearing. Nestlé decided it was not financially viable to continue the legal battle and accepted the restrictions. Under trade investment provisions (in this case, the General Agreement on Tariffs and Trade’s Agreement on Trade Related Investment Measures), Nestlé would have a reasonable chance of success at arguing the permit restrictions were an expropriation of their investment.
As water scarcity becomes more of an issue, governments are likely to place a higher value on water resources. Generous water-taking permits such as Nestlé’s are likely to be reviewed. Investor provisions in trade agreements give foreign-owned companies the ability to challenge these decisions directly. Canada may be hamstrung by foreign investors in the development of more sophisticated water management programs.
Katherine Ruta is with Davis LLP. This article appeared in ES&E’s September/October 2014 issue.