Municipalities and the MAI

Barry Appleton  LL.B., LL.M.

Appleton & Associates International Lawyers(1)

Click on this list to go to the following sections:

How this Change Occurred

The shift from Tariffs.


Investment treaties

The Instruments of Change

MAI Rights

National Treatment

Performance Requirements

Minimum Standards of Treatment

Expropriation

Examples


Public Health & Safety

Municipal Licenses

Land Use Regulation

Subsidies & Incentives

Municipal Procurement

Reservations

Conclusions

Notes

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Over thirty years ago, Marshall McLuhan used the term "global village" to describe a new trend(2). McLuhan’s global village referred to how modern technology, like jet air travel, television and satellite-based long distance telephones, linked remote areas of the world together in new ways. Decisions made thousands of miles away could have an impact at home and local actions could have immediate impact abroad.

As we enter a new millennium, few knew then how correct Professor McLuhan would be. We find ourselves constantly coping with the impact of change. New technology has resulted in shorter time frames and has extended a global reach for business. We need no better proof of this development than to see how financial issues half a world away in Asia have had a direct effect on our domestic stock markets and interest rates. Our new reality is defined by CNN, the internet and corporations which operate on a global basis. As a result, today local issues can immediately have international effect and many types of local issues are now the stuff of global agreements.

Thus, it should not be surprising to find that today the most local of our institutions, civic government, is now the subject of international agreements. This paper will look at how global investment treaties can have an impact on the municipal government. Part I looks at how this change has occurred, Part II examines the key instrument of this change, Part III gives examples of this change; and Part IV deals with general conclusions.

I. How this change occurred

The impact of international law on local government has not occurred overnight but has been influenced by a number of factors over the last fifty years.

The shift away from tariffs

From the late 1940's and onwards, international agreements were pre-occupied with the issue of reducing tariffs. Since the reduction of tariffs resulted in lower protection for domestic industries, it took a considerable effort to achieve meaningful agreements. At first, the focus of international agreements was to local customs duties. By the late 1970's, most duties had been reduced or removed and the focus of attention shifted to new areas: non-tariff barriers(3). The first international agreements were concerned with issues such as product standards or government procurement. However, developed states, like Canada and the United States, continued to push for controls on a new area: foreign investment.

The creation of investment treaties

After the Second World War, American negotiators began to include clauses in American treaties that gave protection to the investments owned by American’s abroad. These clauses usually permitted the U.S. Government to bring a claim before an international tribunal in order to seek restitution for lost property. Eventually, these investment protection clauses became codified into a form of treaty known as a Bilateral Investment Treaty (BIT). The BITs were generally negotiated with developing states and they guaranteed compensation to American investors in the case of expropriation or a failure to provide fair and equitable treatment(4) . The World Bank’s International Center for the Settlement of Investment Disputes (ICSID) reports that since 1987 more than eight-hundred BITs have been concluded.(5)

The successful negotiation of the North American Free Trade Agreement (NAFTA) in 1994 created the first broad investment agreement between developed and developing states. While this agreement also looked at trade issues, it marked the first time that two developed states ever agreed between themselves to accept the onerous provisions of a bilateral investment agreement. The NAFTA contains a broad set of investment obligations. While these obligations applied to all levels of government in Canada, most of the obligations did not apply to municipalities because of technical exceptions and reservations. However, some NAFTA obligations still applied to the actions of municipalities--a fact that the federal government failed to clearly convey to municipalities across Canada.

The NAFTA was the first multilateral agreement to contain a controversial process that permitted individuals themselves, rather than governments, to police these agreements. If a government action violated an obligation in the NAFTA’s Investment Chapter, an individual from another NAFTA Party or its investment could directly challenge that measure before a fast-track international tribunal without the agreement of its home government.(6) The "investor-state" dispute settlement process provides for a fast and effective means of settling disputes between investors and governments by bypassing domestic courts completely. The Investor-State dispute settlement process established in the NAFTA has been described as "an untapped source of extensive private investor rights, including guaranteed access to a NAFTA panel for a private party." (7)   Designed to provide protection for foreign investors in developing countries, the investor-state dispute settlement process focuses strictly on settling investment disputes between individuals and governments.

While the NAFTA was the first step in this process of creating international responsibility for municipal governments, the most significant development in this process is currently at hand--the Multilateral Agreement on Investment.

II. The Instruments of Change

The Multilateral Agreement on Investment,(8) known as the MAI, is an international investment agreement currently under negotiation by the twenty-nine member countries of the Organization for Economic Cooperation and Development in Paris. The goal of the MAI is to establish international standards on how governments treat foreign investors and their investments. The MAI is built upon the framework of the NAFTA’s Investment Chapter. The MAI, in distinction to the NAFTA, is a much broader agreement in that its terms apply to all levels of government without exception(9).  As currently negotiated, the MAI’s obligations will directly apply to the acts of all levels of government, including municipal governments.

Like the NAFTA, the MAI includes a special process to protect the "rights" of foreign investors by allowing them and their companies to challenge local measures that violate their international rights. The Investor-State dispute settlement process allows a foreign investor from an MAI country (both individuals and corporations) to directly bring a compensation claim against another MAI government. These claims are heard before a special international arbitration panel that can award financial compensation to investors that have been harmed by governmental action which infringes the MAI’s investment obligations. The panels cannot strike down MAI-infringing measures but the threat of paying enforceable damage awards can be chastening to government policy initiatives.

MAI investors are entitled to dispute government measures. These measures are not limited to legislation but extend to all acts attributable to governments, including regulations, governmental policies and practices. Not only are the national governments covered by this Agreement, but so are state, provincial, territorial and local governments. An example of the scope of application of the Investor-State process is described by American trade lawyers, Gary Horlick and Alicia Marti as follows:

If Arlington County, Virginia was to deny a zoning variation to Goldstar U.S., while granting a similar one to Micron (or Sony U.S.), could Goldstar Mexico bring the U.S. to an arbitration panel under Chapter 11B? An important issue would be whether Goldstar Mexico had incurred loss or damage by reason of the denial.(10)

The MAI requires that there be some international participant involved in an investment dispute. Any individual resident in an MAI country, or a business owned by that individual, can launch a claim against the government of another MAI country. For example, Canadian investors are not eligible to bring disputes against the Government of Canada; however, American or Japanese investors can. A major exception to this rule is that Canadian corporations "owned or controlled directly or indirectly" by a citizen of another MAI country can bring a claim against Canada.

This results in the situation foreign investors and their investments in Canada have access to the investor -state dispute process while other Canadians may not. In essence, foreign investors are provided with a better legal remedy than Canadians under these rules.

MAI "Rights"

The MAI deals with a number of important government obligations. Among these obligations are the following:

National Treatment

The concept of national treatment is one of the cornerstones of the MAI. It requires governments to treat all investors the same, irrespective of their nationality. This obligation ends government policies that favour local business. For example, national treatment prohibits the imposition of differential fees based on the residency of an investor, such as out-of-district levies for services such as garbage pick-up or education.

Performance Requirements

The MAI restricts the ability of governments to impose a wide variety of practices known as performance requirements. For example, governments cannot require a foreign investor to purchase local goods or services. Governments may also not require an investor to hire local residents as a condition for receiving any benefit, such as a tax concession. Thus, common investment incentives provided by municipalities on the condition that a foreign business locate in the area are effectively removed by the MAI.

Minimum Standards of Treatment

This obligation requires governments to provide due process to foreign investors and their investments. Even if a country treats foreigners as well as locals, this obligation sets a minimum standard of conduct that no country can fall below.

Expropriation

The expropriation provisions of the MAI are perhaps the agreement’s most controversial element. The MAI forces governments to pay compensation whenever there is an expropriation or "a measure equivalent to an expropriation."(11) Under international law, the term "expropriation" is very broad and it applies to any act where a governmental authority denies a person or company some benefit of property.(12)   The government does not need to take title to the property; all it has to do is deny the benefit of the investment to the investor.(13). This international definition of expropriation is not the same as the definition of expropriation under Canadian law--it is far wider.

The MAI is a very generous treaty when dealing with quantifying investor compensation. An investor must receive fair market value for its expropriated property(14) . This valuation basis provides compensation at levels that could be higher than those established under Canadian domestic law. This generous compensation standard augments the broad definition of what constitutes an expropriation under the MAI.

The impact of these MAI obligations is made greater on account of the absence of key limitations in the MAI that are found in other international investment agreements, like the NAFTA. For example, the MAI applies to all advantages granted by governments. The term "advantage" is a broad term which may cover any government subsidy, concession or incentive. The NAFTA specifically exempted subsidies from the application of several parts of the Investment Chapter(15). Provincial and municipal government subsidies that discriminate on the basis of residency or that require local residency could be maintained under the NAFTA, but may be prohibited by the MAI.

A similar expansion of the MAI occurs because of the broad definition of the term "investment." Under the MAI, the term "investment" encompasses every kind of asset owned or controlled, directly or indirectly, by an investor.(16) This term is more broadly defined in the MAI than in the NAFTA or the Canada-U.S. Free Trade Agreement.

III. Examples

While municipalities are not "parties" to the MAI, they are subject to the full extent of the obligations in the MAI although they have absolutely no right to participate in any investor-state dispute hearings that would question their actions.

Public Health and Safety

The MAI contains no public policy exception to the requirement to pay compensation in the event of an expropriation. Thus, if a civic government takes an action to shut down a local business for dumping harmful waste into the local water supply, this action would not relieve the civic government from liability for compensation. The federal government has not included any wording in the MAI that would permit actions to conserve and protect the Canadian environment, public health or safety. Except for a very specific exemption from the performance requirements obligations, the MAI does not have any environmental exceptions. This single limited environmental exemption in the MAI only permits governments to require domestic content or provide a preference to local goods or services only if:

  • the measure is not arbitrary or unjustifiable;

  • is not a disguised restriction on investment; and

  • is necessary to protect human, animal or plant life or is necessary for the conservation of living or non-living exhaustible natural resources.

Without the inclusion of broad easily accessed environmental or public health and safety exceptions or reservations, the MAI’s broad investment rules may result in new limits on the ability of governments to freely meet environmental challenges.

Municipal Licenses

The MAI’s obligations extend to the governmental allocation of concessions and licenses. Thus, issues regarding the awarding of licenses can be the basis of an investor-state dispute. Indeed, the refusal of a municipal government in Mexico to issue a civic license for a waste facility is currently the basis of a $90 million NAFTA expropriation action.

Land Use Regulation

Municipal policies respecting land use regulation regularly impose costs upon investors. Changes in zoning that could restrict the use of land, even including historic designation, could result in effective claims under international law definitions of expropriation. While under domestic law, there can be no compensation for losses caused by changes in land use regulation; this is not true under international agreements such as the NAFTA or the MAI.

Subsidies and Investment Incentives

The MAI national treatment obligation applies to all government measures(17) including subsidy programs and other "advantages" provided by the government. This is a significant expansion of the national treatment requirement in the NAFTA. Because of the national treatment requirement, any advantage provided by a civic government must be offered to any other foreign investor. The only discrimination that is permitted is against Canadian citizens.

The MAI requires that any investment incentives offered to local persons must be made equally available to foreign persons(18). These incentives cannot be based on performing specified requirements. Since small businesses are predominately local, programs that assist them must be equally available to foreign investments, even if they are larger.

Municipal Procurement

The MAI, as currently drafted, contains no exemption for municipal government procurement policies. At a minimum, the MAI performance requirements obligations would severely restrict procurement policies at all levels of government. This could harm the ability of governments to assist community-based suppliers. As currently drafted, the MAI could require municipal governments to provide "transparent" procurement procedures for procurement bids. These bids could be subjected to potential investor claims alleging a violation of national treatment or minimum standards of treatment. The coverage of municipal procurement into the obligations of the MAI would result in increased paperwork and cost for municipal procurement.

In summary, a broad range of municipal functions would be affected by the MAI. In addition, there are existing implications of the NAFTA for the municipal sector. While the NAFTA does not apply to subsidies or to municipal government procurement, it applies to new expropriation, national treatment and performance requirement measures applied made after January 1, 1994.

Reservations

Reservations are special forms of exceptions to international agreements which permit a member to be excused from meeting a specific obligation in a specific way. Because a reservation is a deviation from the objectives of the international agreement, reservations are interpreted very narrowly by international tribunals.

In a document entitled "CANADA: DRAFT RESERVATIONS,"(19) the federal government proposed to make a number of reservations to the MAI. These reservations appear to be identical to reservations made by Canada under the NAFTA(20). No reservations were taken to exempt municipal governments from the obligations of the MAI. In addition, no exceptions were included in the text of the MAI to otherwise exempt municipalities.

Even if reservations were to be made to the MAI for municipalities, it must be pointed out that under the "rollback" provisions of the MAI, these reservations could become subject to eventual negotiation for elimination.

IV. Conclusions

Canadian businesses claim that their investments abroad will be able to obtain advantages from the strong investment protections provided by the MAI(21). Canadian governments, at all levels, will be forced to comply with these protections in Canada. Canada has shown itself to be an attractive place for foreign investors to do business. As a result, Canada has become the host state to a significant amount of foreign investment. With the country’s existing base of foreign investors from the United States, Japan and Europe, the implications of the MAI will immediately have effect throughout the county.

The MAI creates an entirely new multilateral dispute process, vastly different from the GATT or WTO. The ability to allow individuals to directly bring cases against governments (even without the consent of their home government) will have in unpredictable results. What is clear is that the MAI creates a speedy and enforceable process to settle disputes with governments. This is likely to result in investors carefully scrutinizing government practices to find a MAI provision on which they can base a claim. Thus, policing of the MAI will move from governmental channels over to businesses with enforcement done through the use of international tribunals.

With the expansion of Investor-State dispute settlement system throughout the world’s most-developed nations, this trend will only continue to grow.

The MAI investment provisions have quietly created a looming economic constitution that protects the rights of foreign MAI investors investing in each MAI country. The need to take policies that are consistent with these rights will have a number of implications for civic governments:

1. The rules of the game are changing. Municipal governments will find that the rules that apply to them have changed. Appreciating these changes will be even more difficult for municipalities as they traditionally do not have experience interpreting international investment agreements.

2. "Governments would rather switch than pay." Faced with budget restraints and lacking expertise in international investment law, civic governments will need to modify their policies to avoid the high damage awards that panels could assess. However, the simple fact that large damage awards can be assessed for internationally-inappropriate behaviour could leave municipalities unwilling to take actions that could leave them susceptible to later international tribunal review.

3. If a government persists in its goal of implementing MAI-inconsistent actions, that government may be forced rent back jurisdiction. Governments are able to function freely, however, they may have to pay compensation to do what they were elected to do.

Clearly municipal governmental concerns have not been an important factor in shaping the MAI. Instead, the desire of investors to obtain protection from municipal regulation has been reflected. While there is still time to change the MAI, the basic structure and content of this Agreement appears to be complete. There is little doubt that this MAI and its investor-state dispute system will play a major role in how business will be done in North America over the next decade. Municipalities are directly affected by this proposed agreement and it appears that there has been little thought by national governments in finding ways to exempt them. Indeed, some participants in the MAI negotiations have made it clear that they are opposed to any blanket reservations or exceptions for "sub-national" governments as they fear that they will be used as a loop-hole to provide local preferences for local business.

Agreements like the MAI can be helpful in assuring foreign investors that their investment is safe in Canada. However, at the same time, this Agreement will impose significant restraints on all levels of governments. These restraints include the costs of paying compensation awards of foreign investors and new limits on how civic governments can operate respecting foreign businesses. Change is here whether municipalities are ready or not. Professor McLuhan’s global village has come to your village, leaving municipalities with the burden of coping with the change that is before them.

©Appleton & Associates, 1998. All rights reserved

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NOTES

1.
Barry Appleton is the Managing Partner of Appleton & Associates in Toronto and New York City. He is the author of Navigating NAFTA: A Concise User's Guide to the North American Free Trade Agreement. This short paper is based on an address made to the Annual Civic Night Dinner for the Simcoe County Kiwana's Club on January 19, 1998. 

2. Marshall McLuhan, Understanding Media: The Extensions of Man (1964).

3. See John Jackson. The World Trading System: Law and Policy of International Economic Relations (Cambridge, MA., MIT Press; 1989) at 52-57 .

4. A full examination of BITs can be seen in Rudolf Dolzer & Margrete Stevens. Bilateral Investment Treaties (International Centre for the Settlement of Investment Disputes: Washington D.C., 1995).

5. Bilateral Investment Treaties 1959 - 1996: Chronological and Country Data Bibliography (International Centre for the Settlement of Investment Disputes, Washington D.C., 1997) Doc. ICSID/17 at p. v.

6. This process is contained in Section B of NAFTA Chapter 11.

7. Gary Horlick & Alicia Marti, "NAFTA Chapter 11B, A Private Right of Action to Enforce Market Access Through Investments," Journal of International Arbitration, Vol. 14 No.1, March 1997, at 54.

8. All references in this submission are to the May 14, 1997 text. DAFFE/MAI (97) 1/REV 2 unless otherwise noted.

9. Governments are currently negotiating country-specific reservations to the MAI but the scope and impact of these reservations is still under negotiation.

10. Gary Horlick & Alicia Marti, "NAFTA Chapter 11B" at 53.

11. Any direct or indirect expropriation of an investment must satisfy all of the following requirements. The MAI provision requires that it must be:

for a purpose which is in the public interest; on a non-discriminatory basis; in accordance with due process of law; and accompanied by payment of prompt, adequate and effective compensation.

12. The expropriating government need not take formal title to the property in order for there to be an expropriation. The Iran-U.S. Claims Tribunal gave the following definition of expropriation:

It is well settled in the practice of the Tribunal, as elsewhere, that property may be taken under international law through interference by a State in the use of that property or the enjoyment of its benefits amounting to a deprivation of the fundamental rights of ownership.

Sola Tiles Inc. v. Iran (1987), 14 Iran-U.S. C.T.R. 223 at 231-232, par. 29.

13. For example, see Harza Engineering Co. v. Iran, (1982) 1 Iran-U.S. C.T.R. 499 at 504.

14. MAI Part IV: Investment Protection: Expropriation Articles 2.2 - 2.5.

15. NAFTA art. 1108(7)(b).

16. This description includes, but is not limited to, enterprises, debt, equity, contract rights, claims to money, intellectual property, rights granted by laws, such as licenses, and any other tangible or intangible property, whether real or personal, and any related property rights.

17. The national treatment obligation does not apply to revenue taxes (such as income taxes), but it does apply to other taxes such as capital taxes.

18. MAI: III: Treatment of Investors and Investments: Special Topics: Investment Incentives, page 44.

19. DAFE/MAI/RES(97)15 dated February 24, 1997.

20. It is important to note that there are significant differences in the effect of the MAI reservations because of the difference in wording between the obligations in the MAI and the NAFTA.

21. For example, see the Press Release of the Canadian Alliance of Manufacturers and Exporters of December 5, 1997 endorsing the MAI.

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