Application of the NAFTA National Treatment Obligation

Issues and Problems in the Application of the NAFTA National Treatment Obligation: Which comes first – like circumstances or comparison of treatment?

By Jon R. Johnson Goodmans LLP (December 2, 2001)

Lines of cases in WTO jurisprudence frequently establish a precise order in which a particular provision is analyzed. For example, with Article XX of GATT 1994, the Appellate Body will always determine whether the measure falls within one of the specific exceptions set out in Article XX and whether it satisfies the qualifying language of that exception before considering whether the measure satisfies the requirements of the chapeau of Article XX.

No order of approach has been established in the jurisprudence respecting Article 1102. In S.D. Myers, Inc. and Government of Canada (“Myers”) the Tribunal considered “in like circumstances” before addressing the issue of “no less favourable treatment”(See Partial Award by majority (“Myers Partial Award”), paragraphs 243 to 251 (like circumstances) and paragraphs 252 to 257 (treatment)), while in Pope & Talbot Inc. and The Government of Canada (“Pope & Talbot”) the Tribunal proceeded in the opposite order.(See Award on the Merits of Phase 2 (“Pope & Talbot Phase 2 Award”), paragraphs 33 to 72 (treatment) and 73 to 103 (like circumstances)) The Chapter Twenty Panel in In the Matter of Cross-Border Trucking Services (“Trucking Services”)(Secretariat File No. USA-MEX-98-2008-01. This case involved cross-border services rather than investment but Article 1202 is similar in its structure to Articles 1102(1) and (2)), in considering the national treatment obligation in Article 1202 respecting cross-border services, approached the question of treatment first. (Panel Report paragraph 248 et seq)

The logic of Articles 1102(1) and (2) suggests that there is no requirement that treatment being accorded to investors and investments be compared unless the treatment is being accorded “in like circumstances”. This suggests that the question of “like circumstances” should be considered before the question of “no less favourable treatment” because if the circumstances are not “like”, no obligation arises respecting the according of treatment. In Trucking Services, the treatment being accorded to cross-border service providers of Mexico was unequivocally less favourable so the only issue was whether a comparison of treatment was required by reason of the circumstances being “like”. In Pope & Talbot however, while there were different levels of treatment with some more favourable than others, there was a major issue as to whether the less favourable treatment was being accorded to investors (or, at least, an investor) of the United States and more favourable treatment was being accorded to investors of Canada. The Tribunal’s decision would have been much less confusing if it had approached the issue of “in like circumstances” before considering “treatment no less favourable”. In fact, it was patently obvious in this case that the differing treatments were being accorded in circumstances that were not like, so that should have been the end of the matter.

The balance of this paper will consider the issues arising respect of “in like circumstances” first and then will consider the issues respecting “no less favourable treatment”.

Issues respecting “in like circumstances”

Are the “circumstances” those of the investor or the investment or these of the according of the treatment?

Governments frequently treat businesses differently for a variety of reasons. Businesses in built-up or environmentally sensitive areas may be subject to more stringent environmental regulations (with resulting higher costs) than businesses in other areas. Businesses of under a certain size may be categorized as “small businesses” and may be entitled to tax or other concessions. Businesses that choose to operate in economically disadvantaged areas may receive advantages not available to businesses operating in other areas.

One question that arises in respect of “like circumstances” is whether the “likeness” pertains to the circumstances under which the treatment is being accorded (which can encompass a whole range of factors) or whether likeness is confined to the circumstances of the investors and the investments being compared. If the former, differences arising from, say, the region in which an investment is located can be accounted for as “unlike circumstances”. The circumstances under which the treatment is accorded to a business in an environmentally sensitive area are different from the circumstances in which an otherwise identical business in a non-sensitive area are treated are different, so the obligation to compare the two different treatments does not arise. However, if the latter, the fact that the businesses operate in the same sector (both produce widgets) could be enough to establish that the circumstances are “like” and a comparison of the treatment of investors and investments is required.

The Pope & Talbot Tribunal adopted an expansive review of “in like circumstances”, finding that any difference in treatment linked to a rational government policy not motivated by discrimination created a situation of unlike circumstances. However, the panel in Trucking Services noted that the Parties agreed that the phrase “in like circumstances” was intended to have a meaning similar to the phrase “like services and service providers” proposed by Canada and Mexico in the negotiations.(Panel Report paragraph 249) The Trucking Services approach was more in line with traditional GATT/WTO national treatment jurisprudence that compares like products. However, applying the Trucking Services approach to a situation of differential treatment arising from regional differences in environmental sensitivity would likely result in a finding of “like circumstances”. The Pope & Talbot approach to “likeness” in this situation would have reached the opposite conclusion. It is submitted that the situation just described should never be subject to a claim under Article 1102. However, the approaches followed in two different cases considering virtually the same language lead to opposite conclusions when applied to this same hypothetical fact situation.

The foregoing notwithstanding, sector can be important in certain cases (where the measure complained of is sector-specific as opposed to one of general application) and the breadth of the identification of the sector can be critical as to whether the circumstances are “like”. For example, Ethyl Corporation v. Government of Canada (“Ethyl”) involved a ban of cross-border trade in MMT. There were no producers of MMT in Canada.(Including Ethyl, which produced MMT in the United States and whose Canadian subsidiary only diluted and distributed MMT. However, that is another issue). If “like circumstances” were defined by the “MMT producers” sector, there would have been no investors or investments “in like circumstances”. However, if the “like circumstances were defined by the “octane enhancer” sector, there were Canadian investors and investments in like circumstances because there were several Canadian producers of ethanol, which, like MMT, is used as an octane enhancer.

Aims and Effects of Government Policy

The issue here is the extent to which the motivation behind the measures at issue and the different treatment that they accord should be a relevant factor in the “like circumstances” analysis.

Aims and Effects and the GATT/WTO Experience

Aims and effects has had a tortured history in GATT/WTO jurisprudence. Panels in several cases under the General Agreement on Tariffs and Trade 1947 (“GATT 1947”) used “aims and effects” to establish that products were not “like” and therefore the obligation to accord no less favourable treatment under Article III:4 of GATT 1947 did not apply. For example, the panel in United States – Measures Affecting Alcoholic and Malt Beverages (Adopted 19 June 1992, BISD 39S/206) (“Malt Beverages”) was considering whether measures that treated strong beer less favourably than weak beer contravened Article III:4 of GATT 1947. The panel decided that as alcoholic content had not been singled out as a means of favouring domestic over foreign producers so the two varieties of beer did not have to be considered as “like”. However, “aims and effects” has been rejected in WTO jurisprudence as an analytical basis for determining the consistency of measure with national treatment obligations. See for example, Japan – Taxes on Alcoholic Beverages (Japan – Alcoholic Beverages), Panel Report WT/DS8/R, WT/DS10/R, WT/DS11/R 11 July 1996, Appellate Body Report WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R 4 October 1994 and European Communities – Regime for the Importation, Sale and Distribution of Bananas (“EC-Bananas”), Panel Report WT/DS27/R, Appellate Body Report WT/DS27/AB/R 9 September 1997.

In European Communities – Measures Affecting Asbestos and Products Containing Asbestos (WT/DS135/R and WT/DS135/R/Add.1 18 September 2000, Appellate Body Report, WT/DS135/AB/R 12 March 2001)(“Asbestos”), the Appellate Body found that the asbestos-containing products were not “like” non-asbestos containing products used for similar purposes because the health risks shaped consumers’ preferences and not for reasons relating to the purpose of the ban.

The NAFTA Experience

Aims and effects has resurfaced in NAFTA jurisprudence. The Pope & Talbot Tribunal decided in Canada’s favour in respect the national treatment claim on the basis that circumstances were not “like”. After rejecting the arguments of all three NAFTA Parties that the basis of de facto discrimination must be discrimination on the basis of nationality, the Tribunal approached “like circumstances” on the basis it requires “addressing any difference in treatment, demanding that it be justified by showing that it bears a reasonable relationship to rational policies not motivated by preference of domestic over foreign owned investments”.(Pope & Talbot Phase 2 Award paragraph 79) The Tribunal followed this approach throughout its analysis. For example, in respect of the different treatment in non-covered provinces, the Tribunal stated that this was “reasonably related to the rational policy of removing the threat of CVD actions” and could not “reasonably be said to be motivated by discrimination outlawed by Article 1102”.

The issue of the motivation behind a measure as being relevant to the application of “in like circumstances” also arose in the Trucking Services case. The panel stated that “differential treatment should be no greater than is necessary for legitimate regulatory reasons such as safety”.(Panel Report paragraph 258) This analysis was tied to the question of “in like circumstances”, suggesting that the existence of legitimate regulatory reasons can form the basis for a finding of unlike circumstances. Consideration of the existence of “legitimate regulatory reasons” seems consistent with the Pope & Talbot “rational policy” approach to “in like circumstances”. However, the Panel’s view of “in like circumstances” and “legitimate regulatory reasons” was restrictive. This approach may have made sense in the circumstances of this particular case where the service providers of Mexico were unequivocally being treated less favourably than their U.S. counterparts, and the only question was whether the differential treatment was somehow justified. It certainly does not make sense from a broader perspective.

“In Like Circumstances” as an Exception

The panel in Trucking Services expressed the view that the “in like circumstances” language amounted to an exception and should be interpreted narrowly like other exceptions.(Panel Report paragraph 260) The suggestion that the “in like circumstances” language amounts to an exception raises burden of proof issues. WTO jurisprudence respecting burden of proof distinguishes between positive obligations and affirmative defences. If a complainant alleges a breach of a positive obligation, the complainant has the burden of establishing a prima facie case. If, however, the defendant asserts an affirmative defence, the burden of proof is upon the defendant to establish a prima facie case that the defence applies.(See United States – Measures Affecting Imports of Woven Wool Shirts and Blouses from India, Appellate Body Report WT/DS33/AB/R 25 April 1997. See also Brazil – Export Financing Programme for Aircraft, Panel Report WT/DS46/R 4 April 1999, Appellate Body Report WT/DS46/AB/R 2 August 1999). Exceptions such as those set out in Articles XI:2 and XX of GATT 1994 have been treated as affirmative defences in WTO jurisprudence. However, it seems very clear from the text of Articles 1102(1) and (2), as well as Article1202, the requirement that the treatment be accorded “in like circumstances” is a basic requirement of the substantive obligation. The Appellate Body finding in Brazil – Export Financing Programme for Aircraft is instructive. Canada maintained that Article 27.4 of the Agreement on Subsidies and Countervailing Measures (“SCM Agreement”) was a conditional defence and that the burden of proof was on Brazil who was asserting it. The Appellate Body found that a developing country is entitled under SCM Article 27.2(b) to the non-application of SCM Article 3.1(a) provided that it complies with the specific requirements of SCM Article 27.4. These conditions are positive obligations of the developing country and not affirmative defences. Therefore, the burden in this case was on the complaining party (Canada) to establish non-compliance by Brazil with at least one of the elements of SCM Article 27.4.

The burden should be on the complainant to establish that this requirement is met (i.e. that the circumstances are “like”), rather than for the defending Party to establish that they are not. However, the decision in Trucking Services could be used as a basis for arguing the opposite. The ultimate outcome in Trucking Services was reasonable but the Panel chose an unfortunate means for reaching it in treating “in like circumstances” as an exception. It also follows that if the “in like circumstances” language in Articles 1102(1) and (2) is not an exception, it should not be subject to a narrow interpretation.

Inappropriate Comparisons – Producers with Distribution Subsidiaries/Service Providers with Marketing Subsidiaries

As noted above, Article 1101(1)(b) requires that the “investment” with respect to which the treatment must be accorded under both Articles 1102(1) and (2) must be within the territory of the Party according the treatment. There have been two cases under Chapter Eleven in which the investor had an investment in Canada but the real adverse effect of the measure complained of was on investments of the investor in the United States.

In Ethyl, the complaining investor had a Canadian subsidiary that imported MMT, diluted it and distributed it but did not produce it. The real adverse effect of the MMT trade ban was upon the investor’s U.S. facility, which did produce MMT. The investor was complaining that it was being treated less favourably than producers of octane enhancers in Canada. However, the investor did not produce MMT in Canada. Its Canadian subsidiary merely diluted and distributed MMT in Canada. The investor was making its claim based on a comparison of the treatment of its investment in Canada, an octane enhancer distributor, with domestic Canadian investors that were octane enhancer producers, when the entity of the investor that was truly comparable with the Canadian octane enhancer producers was the investors production investment in the United States. This case was settled before being considered on its merits.

The situation in Myers was similar. The investor’s Canadian investment was a marketing subsidiary, and the investor’s PCB destruction facility was located in the United States. The investor claimed that the PCB export ban diverted business from it to PCB destruction facilities located in Canada. These Canadian investments were not comparable with the investor’s Canadian investment, which was a distributor, but with the investor’s U.S. investment that was the PCB destruction facility. The Tribunal found circumstances to be “like” but did not address this issue of comparability. The Tribunal’s decision is subject to judicial review.

Article 1101(1)(b) clearly indicates that Articles 1102(1) and (2) were not intended to have extraterritorial scope. The question that arises therefore, in each of Myers and Ethyl, is whether the treatment of the investor’s investment in Canada, which was a distribution or marketing subsidiary only, was accorded “in like circumstances” to the treatment accorded to Canadian investors and investments that were producers or full service suppliers, when the investment of the investor that was really comparable with the Canadian investors and investments was located in the United States? It is submitted that the circumstances are not “like”, because the effect of holding otherwise is to apply extra-territorial application to Articles 1102(1) and (2), which the NAFTA drafters did not intend. To hold otherwise would enable a U.S. investor to ensure full Article 1102 protection vis à vis laws of Canada for its U.S. production facility simply by incorporating a marketing subsidiary in Canada. The absurd result of this is that a U.S. producer with a small Canadian distribution subsidiary would have full Article 1102 protection vis à vis Canadian laws that adversely affected its U.S. production facility (including a right of direct action against the Canadian Government) while its counterpart without a distribution subsidiary would have no such protection.

Comparing the Canadian distribution subsidiary of a U.S. producer with a Canadian producer or the Canadian marketing subsidiary of a U.S. cross-border service supplier with a Canadian service supplier results in measures coming under Chapter Eleven scrutiny, such as import and export restrictions, that the Parties likely never intended be subject to Chapter Eleven. Such distributing or marketing subsidiaries should only be compared with Canadian-owned investments acting in a similar capacity, and not to Canadian-owned producers or service suppliers who are acting in a different capacity.

Sub-National Governments

The question that arises with subnational governments (provinces and states) as regards “in like circumstances” is whether the circumstances should be confined to those within the province or state or whether “like circumstances” can be outside the territory of the province or state. While the extraterritorial rule in Article 1101(1) is not directed at the territories of provinces or states, Articles 1102(1) and (2) when applied to a province or state make sense only if the treatment accorded by the province or state to investors of other Parties or their investments is compared with the treatment accorded by that province or state to domestic investors and investments. Suppose that the Government of Newfoundland grants water extraction permits in Newfoundland to both Canadian and U.S.-owned investments but the Province of Ontario refuses such a permit to similar U.S.-owned investment, and the U.S investor complains about the Ontario treatment. The circumstances of the investments in Newfoundland, whatever their nationality, are irrelevant, because, as is clear from Article 1102(3), the treatment at issue is the treatment accorded by the Province of Ontario to investments and not the treatment that is accorded by the Province of Newfoundland. (Note that Article 1102(3) expressly says “by that state or province”). The relevant issue in such a complaint is how the Province of Ontario treats domestic investors and investments regarding the issuance of water extraction permits as compared with its treatment of foreign-owned investors and investments.

Article 1102(3) requires one modification to the “like circumstances” analysis as regards sub-national governments in that the analysis of likeness is directed at the circumstances respecting the investors of the Party of which the province or state is a part that receive the most favourable treatment. Article 1102(3) was directed at the phenomenon that provincial and state governments sometimes treat investors of that province or state better than investors of other regions of the Party of which they form a part. However, as seen in the section about De Facto Discrimination in the Treatment No Less Favorable Provisions, Article 1102(3) has been applied by one Tribunal in support of the position that Articles 1102(1) and (2) impose a “best-in-jurisdiction” standard.

Article 1102 should apply to measures of local governments, such as municipalities, in the same manner in which it is applied to other levels of government. Interestingly, while Articles 105 and 1102(3) refer to states and provinces only, the fact that Article 1108(1)(a)(iii) refers to Article 1102 not applying to “existing” measures of local governments implies that other measures of local governments (viz. those coming into existence after January 1, 1994) are subject to Article 1102.

The standard against which the treatment by that local government of foreign investors and investments is to be assessed is the treatment accorded by that local government to domestic investors and investments, and not the treatment accorded by some other local government. Suppose one municipality decides to privatize certain functions such as water supply and a second municipality chooses to retain public control of water supply and refuses to consider overtures by private concerns for privatization. The action of the first municipality is entirely irrelevant to assessing the treatment accorded by the second municipality to foreign investors and investments.

Issues respecting “no less favourable treatment”

In the context of international investment law, according to Article 1102(1) of the NAFTA, contracting parties are required to “accord to investors of another Party treatment no less favorable” than that it accords with other countries. For information on this issue (Treatment No Less Favorable Provisions), click here. This entry also includes the Non-Discrimination provisions under NAFTA Chapter 11.