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The Dispute over Dispute Settlement in NAFTA

Last week it was announced that NAFTA renegotiations will be prolonged into 2018 rather than concluded by the end of the year. The pause in talks provides time for a deeper delve into the complex, and tricky issues negotiators are attempting to tackle, one of which is the fate of the various dispute settlement mechanisms. Each country views them differently, and the Trump administration and members of Congress are also divided. Finding common ground on this issue will be important for any renegotiated deal to succeed.

What are the dispute settlement provisions in NAFTA?

Chapter 11 outlines the mechanism for settling investment disputes through an impartial tribunal. Under this chapter, a foreign investor can sue the government of another country for several reasons, including when it believes it is treated worse than a domestic company or in a manner intended to harm its investment by the other government’s regulations or practices. This provision offers a mechanism for settling disputes outside of local courts in what is seen as a more independent and less expensive procedure. In NAFTA discussions, Chapter 11 is often used interchangeably with investor-state dispute settlement (ISDS) provisions, but ISDS provisions were created in post-NAFTA free trade agreements and so are not the specific mechanisms agreed to by the three countries in NAFTA.

Finding common ground on this issue will be important for any renegotiated deal to succeed.

Chapter 19 is used by countries to bring cases on perceived unfair anti-dumping and countervailing duties. These cases are decided by an independent, binational panel of five arbitrators agreed upon by both parties. They decide the merit of the imposed anti-dumping or countervailing duties based on a country’s domestic laws. For a foreign plaintiff these proceedings are quicker and less expensive than a lengthy appeals process through domestic courts. Rulings made by Chapter 19 panels cannot be appealed to domestic courts making them the final ruling on imposition of duties.

Chapter 20 covers disagreements between NAFTA countries on the application of the agreement. It allows governments to settle divergent interpretations of the trade agreement’s implementation. Under this provision the NAFTA free-trade commission reviews the dispute and makes a judgment.

Why are these dispute settlement provisions an issue?

For the Trump administration, the argument against Chapter 19 revolves largely around issues of U.S. sovereignty and the ability of American trade agencies to impose anti-dumping and countervailing duties where necessary to prevent another country from illegally subsidizing their exports or “dumping” them on the U.S. market at below-cost pricing. Because these binational panels of arbitrators operate independent of domestic courts, they are seen as infringing on the jurisdiction of domestic trade agencies and hindering the president’s ability to utilize these trade remedies as needed. The United States has lost some cases under Chapter 19, most notably to Canada on softwood lumber, one of the common trade irritants among NAFTA parties, heightening the controversy surrounding Chapter 19.

Under the original U.S.-Canada Free Trade Agreement, Canada wanted the United States to do away with anti-dumping and countervailing penalties altogether, which the United States insisted on keeping. The Chapter 19 dispute settlement mechanism was a compromise between the two countries. In addition to Canada and Mexico, many companies support Chapter 19 because it allows them to challenge the imposition of duties in what is perceived as a more neutral way, since the independent panel of arbitrators is considered less likely to be biased than a domestic court.

On Chapter 11, elected officials are divided. Some members of Congress have opposed these types of investment protection mechanisms in trade agreements, saying they provide greater protections to foreign investors than domestic companies and can be used to undermine U.S. environmental and labor regulations. Others, however, are supportive, emphasizing the value of these provisions to protecting U.S. business investments abroad. Unlike Chapter 19, however, the United States has never lost a Chapter 11 case, and while monetary penalties could be assessed against the government if it were to lose, no tribunal has the authority to make or change U.S. law or regulation once imposed.

Chapter 11’s investor protections and the mechanisms for their enforcement are strongly supported by business groups, which see them as crucial in protecting their investments in other countries. In fact, 113 American business associations wrote a letter to members of the administration asking that investment protection and investor-state dispute resolution are maintained in the renegotiations of NAFTA and emphasizing the crucial role they play in protecting U.S. investments abroad.

The United States has also proposed revisions to the Chapter 20 provisions during the current NAFTA negotiations. However, the exact nature of the changes sought is unclear.

Where do things stand in the current negotiations?

The Office of the United States Trade Representative (USTR) in July released formal priorities for the United States in renegotiations between the three NAFTA partners. The priorities, which were designed to strengthen and modernize the 23-year-old trilateral trade agreement, explicitly call out Chapter 19 for removal from the agreement.

Making the removal of the Chapter 19 dispute settlement mechanism a priority for NAFTA renegotiations may prove to be an extremely controversial demand on the part of the United States. Canada has made clear it is unwilling to sign on to a new agreement without the duties appeal protection in Chapter 19. Unlike USTR, Canada’s negotiators did not issue formal priorities in advance of talks but various government officials have said publicly Chapter 19 is a ‘red line’ for Canada and that they would be willing to walk away from negotiations on any agreement in which it was eliminated.

Dispute settlement mechanisms will likely be a key marker of progress & potential success in NAFTA renegotiations. 

Without Chapter 19 North American trade partners fear the United States could impose significant duties on Canada and Mexico freely and trying to appeal these duties through U.S. courts could prove too lengthy and expensive. Some Canadian and Mexican businesses, particularly smaller ones, could end up having to close their U.S. operations rather than pursue claims. However, the United States has also benefited from Chapter 19. NAFTA trading partners have imposed significantly fewer anti-dumping and countervailing penalties on the United States than non-NAFTA trading partners, likely a result of the protections afforded by the resolution mechanism created in Chapter 19.

While USTR’s renegotiation priorities do not directly call out Chapter 11 for removal, it was vaguely referenced in the section on investment: “Secure for U.S. investors in the NAFTA countries important rights consistent with U.S. legal principles and practice, while ensuring that NAFTA country investors in the United States are not accorded greater substantive rights than domestic investors [emphasis added].” While intentionally vague, this section seems to point to a desire to remove or at the very least alter investment protections in the agreement, actions that Mexico and Canada are unlikely to support, and are also opposed by the U.S. business community.

What might happen?

It is unclear how the dispute over dispute resolution will play out in the current round of renegotiations talks. One possibility is that the public expressions of hard lines on these issues are meant to placate domestic constituencies, but are unlikely to hamper moving forward in negotiations. One speculation is that Canada could use Chapter 19 as a bargaining chip, setting it up as a potentially major concession to leverage exclusions for Canadian and Mexican goods in the “Buy America” rules that require purchase of American-made products, including steel and iron, for government procurement projects. Mexico’s renegotiation priorities include a statement to “promote the certainty of trade and investment in North America,” and Mexico specifies that one way to accomplish that would be through modernizing NAFTA’s dispute settlement chapters. That appears to leave the door open to a possible reworking of the controversial Chapter 19.  

Although the dispute mechanisms have been a source of controversy among the three countries prior to renegotiations, domestically for the United States there has been talk of the administration compromising with congressional Democrats who oppose these provisions by expanding them to cover new NAFTA chapters on both labor and environment. Altering the dispute settlement mechanisms in this way may help get congressional approval for an agreement the administration brings back from renegotiations.

Moving into next year, discussions on dispute settlement mechanisms are worth keeping an eye on as they are likely to be one key marker of progress and potential for success in these talks.

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