Metalclad v United Mexican States

Metalclad was the first NAFTA tribunal decision to find a breach of FET, employing the additive approach to incorporate concepts of predictability and transparency, based on the use of those terms in NAFTA’s preamble, into the standard required under Article 1105. ^{Footnote 45} However, the British Columbia Supreme Court set aside the Metalclad award in part. It did so based on its own interpretation of Article 1105, which it found referred only to the MST under CIL, and on the fact that the Metalclad tribunal had cited no authority for finding that transparency formed part of the customary MST. ^{Footnote 46}

Pope & Talbot v Canada

Pope & Talbot followed Metalclad and was the most expansive FET interpretation under NAFTA Article 1105, holding that the standard subsumed other sources of law including general principles, treaties, and the principle of good faith. ^{Footnote 47} The tribunal rejected Canadian and US government submissions that FET was equivalent to the MST, finding that FET entitled investors to MST as well as to “fairness.” ^{Footnote 48} Crucially, the tribunal applied this standard “free of any threshold that might be applicable to the evaluation of measures under the minimum standard of international law.” ^{Footnote 49}

2001 NAFTA FTC Note

Following these and other liberal interpretations of Article 1105, ^{Footnote 50} the NAFTA parties issued the FTC Note in 2001. The FTC Note provides:

This binding interpretation required tribunals to abandon the additive approach to FET and instead apply the customary MST threshold. ^{Footnote 52} Most NAFTA tribunals subsequently accepted this in principle but consistently disagreed with NAFTA party submissions regarding the content of the MST. For example, the Pope & Talbot tribunal (in proceedings subsequent to the issuance of the FTC Note) determined that the MST had evolved over time to encompass a more expansive standard. ^{Footnote 53}

Waste Management II

The tribunal in Waste Management II set what would become the prevailing standard for Article 1105, opining that a state would be in violation of the provision by engaging in “conduct that is arbitrary, grossly unfair, unjust or idiosyncratic, is discriminatory or exposes the claimant to sectional or racial prejudice, or involves a lack of due process leading to an outcome which offends judicial propriety.” ^{Footnote 54} Waste Management II was followed by several other awards that approximated this restatement of the MST in applying it to the individual circumstances in question, using language such as “gross denial of justice” and “manifest arbitrariness” to describe the threshold for finding a breach of Article 1105. ^{Footnote 55}

Denial of Justice

One important foundation of the denial of justice concept is the requirement that claimants exhaust available local remedies for their claim to be admissible at international law, although the scope and content of this requirement has varied greatly in arbitral practice. ^{Footnote 69} “Availability” can also be a nebulous concept, as demonstrated in Loewen Group and Raymond R. Loewen v United States. ^{Footnote 70} There, the tribunal found that an appeal route that could result in immediate execution on the claimant’s assets (a major negative potential consequence) was not “reasonably available.” ^{Footnote 71} The tribunal nevertheless dismissed the claim by reasoning that other potential recourses (filing for bankruptcy or a constitutional appeal to the US Supreme Court) were options the claimant “could reasonably be expected to take.” ^{Footnote 72} Even among critics arguing that this is an extremely and perhaps excessively high threshold, it seems generally accepted that, unless a more expeditious right of appeal can be shown to exist at international law, a cumbersome appeal process alone will not breach the customary prohibition on denial of justice. ^{Footnote 73}

Aside from judicial impropriety, the question arises whether procedural misconduct by administrative authorities can also amount to a denial of justice. Some have suggested that this might affect the requirement to exhaust local remedies. ^{Footnote 74} However, because the right to a fair trial and protection of property are legally distinct state obligations under the MST, denial of justice will likely only arise where property rights are violated without full access to a judicial remedy. The more common position therefore seems to be that administrative procedural misconduct appropriately falls under the requirement for “compliance with procedural criteria” or due process under the modern MST, not rules governing the administration of justice. ^{Footnote 75} The unavailability of local remedies, or denial of justice, was therefore not in question in Bilcon.

Due Process

While generally more concerned with procedural fairness in judicial, rather than administrative, proceedings (which are discussed below), the question of due process was relevant in Bilcon because it is triggered when decision makers lack impartiality or follow strong public feeling on an issue. ^{Footnote 76} Such lack of impartiality was one of the factors underpinning the Bilcon tribunal’s main findings regarding the conduct of the JRP. ^{Footnote 77}

Substantive review of domestic decision-making is an extremely contested aspect of the due process obligation. However, it has been suggested that this may be appropriate where domestic decisions are driven by “manifest ill-will towards foreigners.” ^{Footnote 78} Nevertheless, Paparinskis argues that a better approach would draw on practice in the field of human rights, which focuses on whether decisions provide sufficient reasoning, rather than on their specific content. ^{Footnote 79} In this light, it is at least arguable whether the JRP decision considered in Bilcon passes the test of sufficient reasoning, given some of the tribunal’s questions in this regard. ^{Footnote 80} In other words, the JRP decision may have been unreasonable from a due process perspective — the Bilcon tribunal used the term “arbitrary.” ^{Footnote 81}

The classical customary MST has assessed “reasonableness” of due process with strong deference to states, with more than mere “substantive unreasonableness” required. ^{Footnote 82} The remainder of this section takes up the question of whether the modern threshold for finding arbitrariness remains high or has evolved to a lower standard.

Non-Discrimination

The degree to which the customary MST included an obligation for host states not to engage in discriminatory treatment of aliens was a central issue in debates concerning the scope of the classical standard and was an important question in early NAFTA decisions on FET. ^{Footnote 94} Following the FTC Note’s clarification that a breach of another NAFTA provision does not establish a breach of Article 1105(1), NAFTA tribunals have rejected non-discrimination as an element of the customary MST and have relied on explicit non-discrimination provisions found elsewhere in NAFTA Chapter 11. ^{Footnote 95}

Since non-discrimination regarding aliens and their property is a well-established element of classical CIL, this rejection of non-discrimination as a component of MST may indicate a shift in the content of CIL in this area. However, the previously widespread acceptance that non-discrimination forms part of the MST under CIL means that evidence of contrary state practice and opinio juris beyond what has been seen so far would be required before reaching such a conclusion. ^{Footnote 96} More likely, the adoption of specific non-discrimination provisions in IIAs has led tribunals to rely on these provisions, rather than on the more general MST requirement, in adjudicating disputes. It seems not unreasonable for tribunals to adjudicate investor–state disputes based on the specific language of the treaties from which they derive their jurisdiction, rather than on the more general rules that govern relations between the traditional subjects of international law — that is, states. It may therefore be reading too much into this shift in arbitral practice to suggest that it represents a rejection of non-discrimination as a component of the MST.

Transparency

The MST as defined in Waste Management II refers to “a complete lack of transparency and candor in an administrative process,” indicating that basic transparency or candor is sufficient and implying a high threshold for finding a breach. Other tribunals have framed this requirement more rigorously as obligating the state to act “totally transparently in its relations with the foreign investor,” in light of the principle of good faith. ^{Footnote 97} Paparinskis argues that the transparency requirement should be assessed under the rubric of formal and procedural safeguards, not reasonableness or expectations. ^{Footnote 98} Importantly for the Bilcon decision, such an approach would require that decision making be in compliance with domestic law.

Investment tribunals can and do consider apparent breaches of domestic law in the transparency analysis; however, the trend seems to be to focus on “broader improprieties” as opposed to technical violations of domestic law. ^{Footnote 99} Transparency also requires that rules be foreseeable and predictable to the “diligent investor,” possibly requiring that claimants have sought competent legal advice. ^{Footnote 100} If the rules underlying or forming the basis of a decision regarding the investor are unintelligible, this may support a claim of non-transparency. ^{Footnote 101} Finally, representations by officials do not remove the onus on the investor to look into the actual position under domestic law, nor do they alter the status of domestic law as the benchmark the investor should seek to meet unless the officials are authorized to interpret that law authoritatively. ^{Footnote 102} This corresponds to the dissenting position in Bilcon, which held that representations by state officials could create no legitimate investor expectations beyond the default expectation of administrative compliance with domestic law. ^{Footnote 103}

Due Process in Administrative Proceedings

Investment tribunals have applied similar reasoning in assessing claims based on breaches of administrative due process and judicial denial of justice, although the due process requirements are less strict in the former context. For example, the tribunal in International Thunderbird Gaming Corporation v United Mexican States took this approach but found no breach of the MST despite procedural “irregularities.” ^{Footnote 104} In assessing administrative due process claims, tribunals have looked at the adequacy of notification, the effectiveness of participation, the level of impartiality and integrity on behalf of the decision makers, and the availability of judicial review. ^{Footnote 105} Since claims for the violation of administrative due process often overlap with claims for arbitrariness, this discussion is continued in more detail below.

Legitimate Expectations

The protection of investors’ legitimate expectations is an important element of MST. However, as indicated above, its content under treaty or CIL is difficult to delineate and generally overlaps with, and often underpins, other principles such as good faith or consistency and transparency of the administrative framework and decision making. ^{Footnote 106} Regarding expectations arising from state conduct, some early (non-NAFTA) tribunals found that the MST protected investor reliance on state acts “cloaked with the mantle of governmental authority,” regardless of whether they were illegal under domestic law. ^{Footnote 107} However, the Waste Management II tribunal stated that investors’ reasonable reliance on state representations was only relevant in assessing a breach of the MST. ^{Footnote 108} As discussed above, such reasonable reliance probably requires an objective inquiry into domestic law, which remains the benchmark for setting legitimate expectations. Of direct relevance to Bilcon, encouraging remarks from government officials cannot in themselves create legitimate expectations. ^{Footnote 109}

Good Faith

Tribunals have often turned to the principle of good faith in grappling with the vagueness of FET and the MST. ^{Footnote 110} Good faith underlies, and is reflected in, the concepts of FET and the minimum standard, although tribunals have doubted its additive value as a source of positive obligations in its own right. ^{Footnote 111} Good faith is a broad principle underlying other MST protections, such as due process and legitimate expectations. ^{Footnote 112} While it may be useful as a versatile analytical lens for interpreting treaty provisions and assessing breaches of other rights and obligations, this requires that such rights or obligations already exist. ^{Footnote 113} As such, the good faith principle should not be used to impose new obligations where the “usual law-making criteria” have otherwise not been met. ^{Footnote 114}

The ELSI Case

ELSI has been extensively cited as the leading modern case on the definition of arbitrariness in the international law governing the treatment of aliens. ^{Footnote 120} In articulating the “willful disregard of due process of law” standard, the ICJ in ELSI went further and clarified that mere domestic illegality does not amount to arbitrary conduct at international law. The two most relevant passages read:

The language of wilful disregard of due process and juridical shock or surprise in ELSI is remarkably similar to that of acts amounting to “outrage, to bad faith, to wilful neglect of duty, or to a [readily recognizable] insufficiency of governmental action” in Neer. ^{Footnote 122} The high threshold in ELSI thus conforms to the classical approach of procedural scrutiny but with substantive deference regarding governmental acts. ^{Footnote 123} This is appropriate because, while the prohibition of arbitrariness is an uncontested rule of international law, the notion of substantive administrative arbitrariness is extremely problematic. ^{Footnote 124} It would allow tribunals to review domestic decisions without the requirement that the claimants exhaust local remedies, as applies to denial of justice claims. ^{Footnote 125} Some elaboration on this is required.

First, the majority’s approach in ELSI has been criticized for suggesting that state conduct towards foreign investors is not arbitrary so long as it has a lawful basis and provides for recourse to domestic courts. ^{Footnote 126} Although the majority in ELSI found no conduct amounting to arbitrariness at international law, Judge Stephen Schwebel, in dissent, found that the state measures in question were arbitrary. This was because local courts had found the conduct in question to be arbitrary. The conduct was not only illegal but also “unreasonable and capricious,” as it had been undertaken to assuage public opinion, and the damage to the investor resulting from the conduct had not been corrected by its reversal in the domestic courts. ^{Footnote 127} This analysis comes closer to the substantive review of government measures, using a standard of review of reasonableness. ^{Footnote 128}

However, even under this closer substantive scrutiny and with this lower threshold, it is questionable whether the claim in Bilcon would satisfy the arbitrariness standard set out in Judge Schwebel’s dissent. It is true that the “community core values” standard adopted by the JRP appears to have been intended to give voice to public opinion in the EA process. ^{Footnote 129} However, in Bilcon, the claimant did not have a determination by a domestic court regarding the arbitrariness of the JRP process and so could not show what damage might or might not be undone by its reversal. The facts in Bilcon therefore satisfy only one of the three elements in Judge Schwebel’s arbitrariness analysis. A fortiori, the JRP conduct in Bilcon would almost certainly not meet the higher threshold for arbitrariness set out by the ELSI majority. The following section demonstrates how NAFTA tribunals have consistently agreed with the ELSI position that “something more” than mere illegality is required to constitute arbitrary state conduct at international law. ^{Footnote 130}

Waste Management II

In this case, the investor alleged that the Mexican government and a state-owned bank violated Article 1105 by not honouring contractual exclusivity terms and not providing promised landfill sites, largely in deference to local resistance to private waste collection. ^{Footnote 135} The tribunal considered arbitrariness as a stand-alone element of FET. In rejecting the Article 1105 claim, the tribunal applied a high threshold for finding arbitrariness, explaining that Mexico’s conduct was not “wholly arbitrary” or “grossly unfair.” ^{Footnote 136} The tribunal explicitly stated that something beyond contractual breach was required to constitute arbitrary conduct — for example, the combination of “outright and unjustified repudiation” of the transaction or preventing a creditor from accessing remedial recourse. However, the tribunal did suggest that a breach motivated by “sectoral or local prejudice” would support a finding of arbitrariness. ^{Footnote 137}

GAMI Investments v United Mexican States

In GAMI, the investor alleged that Mexico had selectively enforced its laws and regulations in a manner that substantially destroyed the value of the investment. ^{Footnote 138} The tribunal stipulated that a government’s failure to implement its own laws and regulations, leading to harm to an investor, “may but will not necessarily” lead to a breach of Article 1105. It also emphasized the role of context, noting that

The tribunal opined that maladministration exceeding the threshold of “outright and unjustified repudiation” of relevant regulations could violate Article 1105, again emphasizing the importance of context. ^{Footnote 140} This reading might lend support to the majority decision in Bilcon, which combined the question of illegality with a finding of discriminatory conduct. However it should be noted that Waste Management II, decided in the same year as GAMI, is cited with far more frequency.

Cargill v United Mexican States

Cargill involved a dispute arising from Mexico’s imposition of protections in the sugar industry, including taxes and import restrictions on US non-sugar sweeteners that the investor was in the business of importing to Mexico. ^{Footnote 141} The investor argued, inter alia, that Mexico’s conduct was arbitrary because it had denied import permits, and when the investor inquired what it needed to do so that permits could be obtained, it was told that none could be issued because the government had provided no criteria for obtaining them when it set the import permit requirement. ^{Footnote 142} The tribunal reiterated that “inconsistent or questionable” application of policies or procedures does not automatically equate to arbitrariness under international law. ^{Footnote 143} However, it concluded that the opaque import permit requirement was in fact arbitrary because it was calculated to harm the investor as much as possible as part of a broader strategy of inducing a change in US government trade policy. ^{Footnote 144}

On this analysis, Cargill (like GAMI) might seem to support the majority reasoning in Bilcon regarding the misapplication of domestic law coupled with an element of discrimination. However, the Cargill tribunal echoed Neer and ELSI in setting an extremely high threshold for such a finding, requiring an “unexpected or shocking” repudiation of a policy’s purpose or goals or conduct that “grossly subverts” domestic law or policy for ulterior motives. ^{Footnote 145} Beyond arbitrariness, the Cargill tribunal found that the imposition of the import permit requirement (and not its mere misapplication) for the express purpose of destroying the investment was “manifestly unjust” and “more akin to an action in bad faith.” ^{Footnote 146}

Glamis Gold

The Glamis Gold decision was issued a few months before Cargill, but it is discussed here due to its relevance to the subsequent debate in Merrill & Ring and Bilcon. In Glamis Gold, the Canadian investor was granted preliminary permission by the US Department of the Interior to build a gold mine on federally protected land in California, for which approval was later withdrawn. This withdrawal coincided with new state regulations imposing requirements on metallic mines, which the investor argued constituted arbitrary measures intended to permanently block its planned operation in violation of Article 1105. ^{Footnote 147} In setting the threshold for finding such a violation, the tribunal referred to the classical standard:

In rejecting the investor’s argument that the MST had evolved beyond the Neer standard, the tribunal specifically observed that the “abundant and continued use of adjective modifiers throughout arbitral awards” evinced a strict standard. ^{Footnote 149} It cited the ELSI decision, reaffirming that arbitrary conduct “contravenes the rule of law, rather than a rule of law” to a degree that would surprise tribunals. ^{Footnote 150} The tribunal further acknowledged that the impugned measures departed from settled California mining law but that they were not arbitrary because they were generally applicable and not manifestly lacking due process or reasoning connecting them to the purpose of environmental protection. ^{Footnote 151} Finally, the tribunal rejected the argument that the measure upset the claimant’s legitimate expectations since the existing legal regime or preliminary approval of the investment were not “specific assurances.” ^{Footnote 152}

Glamis Gold has been criticized as departing from other post-FTC Note decisions in requiring that the claimant adduce evidence establishing the specific CIL standard on which it relied in order to succeed. ^{Footnote 153} Criticisms include that the tribunal accepted this evidentiary burden, as urged by the United States, when previous tribunals had rejected such a requirement and that the tribunal did not elaborate on the standard of proof of opinio juris required to satisfy this burden. ^{Footnote 154} Margaret Ryan questions the tribunal’s failure to consider: (1) whether it could assess the MST without reference to opinio juris or (2) “whether the method of proving custom might have evolved beyond the traditional two elements theory” (of requiring state practice and opinio juris). ^{Footnote 155} With respect, this position is unconvincing, not least because in the same paragraph the author acknowledges “general consensus” among legal scholars “that custom is a joining of state practice and opinio juris” and notes that proof of opinio juris is still required by the ICJ. ^{Footnote 156} Although she acknowledges that limiting the scope of Article 1105 in favour of maintaining regulatory authority and sovereignty is a justifiable goal, Ryan argues that the Glamis Gold tribunal struck the wrong balance in this regard and suggests that the less restrictive standard of arbitrariness set in Merrill & Ring may be preferable. ^{Footnote 157} This author respectfully disagrees.

Legitimate Expectations

Bilcon claimed to be “specifically encouraged by government officials and the laws of federal Canada to believe that they could succeed.” ^{Footnote 164} Tribunals very rarely agree that a legal regulatory regime can in itself encourage specific investments, and it is doubtful that the tribunal would have found the particular regime in this case to be a sufficient basis for the formation of legitimate expectations in the absence of specific encouragement by government officials. However, the tribunal found that government authorities repeatedly encouraged Bilcon to pursue the Whites Point project and gave no indication that the area was off-limits to projects of that type. ^{Footnote 165} The dissenting arbitrator, Donald McRae, took issue with the relevance of this finding. McRae argued that encouragement by government officials is irrelevant to the expectation that host state laws will be applied to the regulatory approval process, since “[t]hat is an expectation that an investor would have independently of any assurances or encouragement.” ^{Footnote 166}

Under the Waste Management II standard, reasonable reliance on representations by state officials is relevant in evaluating a breach of the MST. ^{Footnote 167} However, as seen earlier in this article, even specific encouragements by state officials do not guarantee approval of a project or continuity in legal standards or relieve the investor of the responsibility to seek independent competent legal advice unless the state officials in question are authorized to provide authoritative interpretations of the law. ^{Footnote 168} McRae’s argument that Bilcon could only legitimately expect compliance with domestic law seems to be confirmed, as the tribunal acknowledges that “all the relevant encouragement was in the context of Bilcon being required to present a project that would comply with federal and provincial laws concerning the environment.” ^{Footnote 169}

Lack of clarity regarding the substance of regulations or the basis of a decision may support a claim for non-transparency. ^{Footnote 170} However, the “community core values” applied in the JRP process may be more of a criterion that Bilcon failed to appreciate fully and satisfy than one it could not understand. Although reference to this concept was a novel approach by an administrative body, which potentially attracts less deference than legislative change, the JRP process provided Bilcon the opportunity to present evidence as well as receive substantial reasons for the resulting recommendation. ^{Footnote 171} Finally, even if the JRP process or standards were in some sense unclear, they fell well short of the threshold in Cargill of an “unexpected or shocking repudiation of a policy’s very purpose or goals” or which grossly subverts domestic law or policy for ulterior motives, rising to the level of bad faith. ^{Footnote 172} As such, the argument that legitimate expectations provide a basis for the tribunal’s finding that Article 1105 was breached is tenuous at best.

Arbitrariness

Bilcon claimed that the evaluative approach based on “community core values” adopted by the JRP was arbitrary in being “unprecedented” and “inimical to the proponents having any real chance of success.” ^{Footnote 173} As outlined above, arbitrariness requires some element in addition to illegality under domestic law, such as “sectoral or local prejudice.” ^{Footnote 174} The idea that the JRP process was arbitrary in combining domestic illegality with local prejudice is not entirely unfounded, as there was evidence that local resistance to the project was considered in the JRP decision-making process. ^{Footnote 175} This is especially relevant in light of the tribunal’s finding that the national treatment obligation under Article 1102 was also breached, notwithstanding the FTC Note’s statement that a breach of other provisions does not automatically give rise to a breach of Article 1105.

However, the “sectoral or local prejudice” found in Bilcon takes the form of a duly appointed administrative panel setting a threshold for an environmental assessment that took into account the project’s effects on the local social environment and that incorporated local perspectives into that assessment. There was no allegation that the JRP intentionally exceeded its mandate — only that it made an error regarding the extent of that mandate. In criticizing the threshold set by the JRP in good faith, the Bilcon majority engaged in a substantive review of the decision, which should attract far more deference than review of procedural safeguards under the customary MST, as expressed in Neer and ELSI. Rather than apply the test of judicial shock or outrage from those cases, or require that the claimant establish the existence of a different CIL standard, including a demonstration of relevant opinio juris, the tribunal determined that the JRP’s conduct was arbitrary because it “effectively created, without legal authority or fair notice to Bilcon, a new standard of assessment rather than fully carrying out the mandate defined by the applicable law.” ^{Footnote 176}

McRae disagreed with the majority’s conclusion that the JRP approach applied a standard of assessment outside its legal mandate, arguing instead that this was an open question:

Again, and in line with the above analysis, McRae pointed out that demonstrating a possible violation of domestic law does not inherently establish a violation of Article 1105. ^{Footnote 178} The tribunal agreed that even proven substantial errors in applying national laws “do not generally, let alone automatically, rise to the level of international responsibility vis-à-vis foreign investors,” and it stipulated that the “trigger for international responsibility” was specific to the facts of the case. ^{Footnote 179} McRae nevertheless raised the concern that an error of law by an administrative panel “now becomes the basis for a NAFTA claim allowing a claimant to bypass the domestic remedy provided [by federal courts] for such a departure from Canadian law.” ^{Footnote 180}

In reaching its determination of arbitrariness, the majority in Bilcon seems to have been influenced by the lower threshold set in Merrill & Ring, specifically citing the passages of that decision arguing for an MST standard that has evolved without independent evidence of supporting opinio juris. ^{Footnote 181} As outlined above, this assertion is highly suspect on both legal and logical grounds. The Bilcon tribunal further opined that the international MST “has evolved in the direction of increased investor protection precisely because sovereign states — the same ones constrained by the standard — have chosen to accept it.” ^{Footnote 182} However, the NAFTA parties do not appear to have accepted such an evolution. In response to liberal interpretations of the FET obligation, they issued the FTC Note in 2001, explicitly linking FET to the customary MST. Since then, they have consistently advocated a high threshold for finding a breach of Article 1105. ^{Footnote 183} In short, the reasoning given by the majority in Bilcon for adopting a lower threshold in finding a breach of FET under Article 1105, rests on faulty assumptions and a misreading of the development and content of the MST of aliens at CIL.