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New York Law Journal
October 27, 2000
ENVIRONMENTAL LAW
The 'Metalclad' Decision Under NAFTA's Chapter 11
Stephen
L. Kass and Jean M. McCarroll
A recent article by one of the
authors traced the history and analyzed the potential significance of
environmental arbitration awards under Chapter 11 of the North American Free
Trade Agreement (NAFTA), which provides a direct private remedy against the
U.S., Canadian and Mexican governments by "investors" from any other
NAFTA party whose property has been expropriated, directly or indirectly, by
governmental action (see "NAFTA's Chapter 11: Regulatory Takings
Revisited," Stephen L. Kass, New York Law Journal, Sept. 11, 2000, p. S-2).
Written in late August, that
article reviewed the first two arbitration awards under Chapter 11 (Azinian,
Davitian and Baca v. Mexico; and Pope & Talbot Inc. v. Canada) and concluded
that, despite early alarms by some environmentalists, expropriation claims under
Chapter 11 were unlikely to significantly disturb U.S. "takings" law
or to chill the passage or enforcement of environmental laws within any of the
NAFTA countries.
The article did, however, warn
that similar provisions in other proposed trade agreements (including the Free
Trade Agreement of the Americas) could chill environmental enforcement in
developing countries and criticized the closed, virtually secret Chapter 11
arbitration procedures, which typically exclude amicus participation by
non-governmental organizations and limit public knowledge of the status, or even
the existence, of such proceedings.
'Metalclad':
Optimism Premature
The newest Chapter 11 decision, Metalclad
Corp. v. Mexico, suggests not only that these procedural concerns are real but
that the earlier article's optimism that such "takings" claims would
not chill environmental regulation within the NAFTA countries may have been
premature.
The Metalclad award found
that Mexico had, through the actions of a local municipality, effectively
expropriated the property of a U.S. investor that had secured all required
permits from Mexican federal authorities to construct and operate a hazardous
waste facility and that the U.S. firm was therefore entitled to recover $ 16.5
million (plus interest) directly from Mexico. The decision, issued as the
earlier article was going to press, has shocked those environmentalists and
governmental officials in the three NAFTA countries who have been working to
enhance and "harmonize" environmental enforcement and thus to prevent
the "race to the bottom" predicted by labor unions and others who view
free trade as a convenient way to circumvent hard-won U.S. environmental
standards.
However, despite some overly broad
language and one major procedural oddity, the Metalclad award reflected
facts that are likely to confine the award's significance to a relatively small
class of governmental actions that could well give rise to similar relief under
U.S. domestic law. As discussed below, the long-term significance of Metalclad
may be to emphasize the importance of predictable environmental standards and
permit procedures, at both the federal and local levels, in each of the NAFTA
countries.
While this may impose short-term
burdens on federal regulators in all three countries, over the longer term it
could also contribute to improved environmental regulation for the public and
for both foreign and domestic investors.
The 'Metalclad'
Dispute
Because the facts are crucial to
understanding the basis for, and limits of, the Metalclad decision, it
is useful to examine them in some detail. As will be seen, the dispute raised
issues relating to federalism, due process, environmental impact and investor
reliance with which U.S. lawyers are already painfully familiar.
In January, 1993 Mexico's National
Ecological Institute (INE) issued a federal permit to a Mexican firm known as
Coterin to construct a hazardous waste landfill in the sparsely populated La
Pedrera valley in the State of San Luis Potosi, approximately 70 kilometers from
the City of Guadalcazur. Shortly thereafter, Metalclad, a Delaware
corporation, entered into an option agreement to acquire Coterin, together with
its permits, in order to construct and operate the facility. In May 1993, the
State of San Luis Potosi granted Coterin a land use permit for the landfill,
subject to compliance with applicable technical requirements and the caveat that
the permit did not authorize the facility's operation. Metalclad
claimed (and the arbitrators appear to have agreed) that both INE's president
and the director-general of Mexico Secretariat of Urban Development and Ecology
(SEDUE) advised Metalclad that, except for a federal operating permit,
all required permits for the facility had been secured by Coterin. In August
1993, INE issued the landfill operating permit, and in September 1993, Metalclad
exercised its option to purchase Coterin.
Local opposition was intense. The
Governor of San Luis Potosi at first denounced the project, and then, after
months of negotiation, appeared to Metalclad to support it. In May
1994, having secured an 18-month extension of the INE construction permit, Metalclad
commenced construction of the landfill, which was inspected by both state and
federal representatives as construction progressed. However, in October, 1994,
the City of Guadalcazur ordered a halt to construction, allegedly for failure to
obtain a municipal construction permit. Metalclad claimed (and Mexico
denied) that INE assured it that, while no municipal permit was required, it
would facilitate amicable relations to secure such a permit, which could not be
denied by the City. Metalclad therefore applied for a municipal
construction permit and, having received INE approval for completion of the
facility, resumed work on the landfill. In early 1995, the University of San
Luis Potosi issued a study on the landfill's environmental impact, finding that
proper engineering would make the landfill site suitable
for hazardous waste operations. A
similar conclusion was reached by PROFEPA, the independent federal office for
environmental protection. The facility was scheduled to open in March 1995. The
opening ceremonies, however, were blocked by demonstrators, allegedly with
assistance from local state troopers. As a result, the landfill remained closed
until November 1995, when Metalclad entered into a "Convenio"
with INE and PROFEPA providing for the landfill's operation and requiring Metalclad
to carry out specified remediation measures at the site, designate a portion of
its property as a reserve for native species, create a scientific advisory
committee to monitor the remediation work, provide semiannual seminars on
hazardous waste management to local officials and the public, provide a discount
for locally generated hazardous waste, contribute various sums to local civic
organizations and provide free medical services to the Guadalcazar community.
None of this impressed the
Guadalcazar city council, which, without notice to or any opportunity to comment
by Metalclad, promptly denied Metalclad's still-pending
request for a municipal construction permit. Shortly thereafter, Guadalcazar
also brought suit challenging the federal Convenio and succeeded in securing a
preliminary injunction until the action was finally dismissed. While the action
was pending, INE granted Metalclad a further permit authorizing a
substantial expansion of the landfill capacity, though the facility remained
dormant, presumably because of the preliminary injunction and the alleged
necessity for the municipal construction permit. In September 1997, as his term
was expiring, the Governor of San Luis Potosi issued a decree establishing a
protected natural area that included the landfill site, thereby effectively
preventing the landfill's operation, without reference to the municipal permit.
Chapter 11 Arbitration
Frustrated, on Jan. 2, 1997, Metalclad
demanded arbitration under NAFTA's Chapter 11, contending that Mexico was
responsible under international law for the conduct of its political
subdivisions and that San Luis Potosi and Guadalcazar had violated NAFTA §1105
(requiring "fair and equitable treatment" of investments in accordance
with international law) and §1110 (prohibiting any party from directly or
indirectly expropriating investments, or taking any measure
"tantamount" to expropriation, without compensation). As contemplated
by Chapter 11, Metalclad's claim was heard by a panel of three
arbitrators under the auspices of the International Centre for Settlement of
Investment Disputes (ICSID), which has no provision (absent the parties'
consent) for public disclosure of arbitration proceedings or amicus
participation, other than by the NAFTA parties.
More than three and one-half years
after Metalclad's demand, the arbitrators found that Mexico had indeed
violated both §§1105 and 1110. Despite the actions of its federal agencies in
permitting and otherwise facilitating the landfill, Mexico conceded that it was
responsible under both NAFTA and international law for the conduct of its
political subdivisions, Guadalcazar and San Luis Potosi.
An underlying purpose of NAFTA,
said the arbitrators, is to increase cross-border investments and, to this end,
the "transparency" of relevant legal requirements for carrying out
such investments successfully. "There should be no room for doubt or
uncertainty on such matters. Once the authorities of the central government of
any party ... become aware of any scope for misunderstanding or confusion in
this connection, it is their duty to ensure that the correct position is
promptly determined and clearly stated so that investors can proceed with all
appropriate expedition in the confident belief that they are acting in
accordance with all relevant laws." Metalclad had been advised by
federal officials that all required permits for the landfill had been received.
Mexico's General Ecology Law, said the arbitration panel, clearly vests
authority over both the construction and operation of hazardous waste facilities
in the federal government, limiting municipal jurisdiction to nonhazardous
wastes and, at most, to the actual construction (rather than the operation) of Metalclad's
facility.
Yet, Guadalcazar had denied a
construction permit for reasons related to the landfill's proposed operation and
had done so without even minimum procedural due process. Moreover, the federal
government itself "failed to ensure a transparent and predictable framework
for Metalclad's business planning and investment."
Unfair Treatment
All this, held the panel, amounted
to unfair and inequitable treatment that, by preventing Metalclad from
operating its completed facility, violated §1105. This was not inconsistent,
said the panel, with NAFTA §1114, permitting a party to ensure that investments
meet environmental standards, because both the federal permits and the Convenio
demonstrated that Mexico was in fact satisfied with the project's environmental
impacts.
The panel also found that
Guadalcazar's denial of the construction permit, combined with the belated
creation of an ecological preserve by the State of San Luis Potosi, amounted to
an expropriation of Metalclad's investment under §1110. Such an
expropriation, said the panel, includes not only formal condemnation, "but
also covert or incidental interference with the use of property which has the
effect of depriving the owner, in whole or in significant part, of the use or
reasonably-to-be-expected economic benefit of property even if not necessarily
to the obvious benefit of the host State."
Because it had permitted
Guadalcazar to block operation of a federally permitted hazardous waste
landfill, without any "timely, orderly or substantive basis" for the
City's action, Mexico had taken an action that was "tantamount to
expropriation." While Guadalcazar claimed to be concerned about the
landfill's environmental impacts, the panel held that it acted outside its
authority in considering such federally preempted subjects. Similarly, the
ecological preserve belatedly decreed by San Luis Potosi's governor effectively
barred landfill operations and was therefore an independent basis for a finding
of expropriation, regardless of its motivation.
Damages Awarded
The panel next turned to the
damages to be awarded Metalclad. Since the landfill was not a going
concern, it rejected Metalclad's demand for the discounted value of
projected future earnings, instead assessing damages equal to Metalclad's
actual investment (less certain preliminary and soft costs) in reliance on the
INE permits for landfill construction. However, this sum was reduced by
significant avoided remediation costs that the panel assumed would now be borne
by the Mexican government in its capacity as de facto owner of the expropriated
site. This brought the total award to Metalclad to $ 16.5 million,
including interest from the effective date of the taking.
Chapter 11 Claims
The Metalclad award has
caused concern among environmentalists in all three NAFTA countries not because
of its facts - which made a compelling case for some compensation to an investor
which had expended substantial sums to build an environmentally responsible
facility it was not allowed to operate - but because of the panel's overly broad
language and its apparent downgrading of "environmental concerns" that
conflict with investors' expectations. In particular, the panel's definition of
"expropriation" includes "incidental interference with the use of
property," even if it does not deprive an investor of all economic use of
the property (an issue not presented by the facts of Metalclad itself).
Critics have also pointed to the panel's failure to note that regional
environmental protection is also an important NAFTA objective and the panel's
use of NAFTA's "transparency" goal to imply an affirmative duty on
Mexican federal officials to provide, as part of "fair and equitable
treatment," an unambiguous roadmap to all local, state and federal
approvals for proposed NAFTA-based investments. It is also striking that the
panel felt called upon, and competent, to decide important questions of Mexican
environmental law, in particular the permitted scope of municipal regulation
over hazardous waste facilities, rather than either requiring Metalclad
to litigate that issue domestically or referring the issue directly to the
Mexican courts for guidance. Finally, the irony of closed arbitration
proceedings to litigate the scope of NAFTA "transparency" obligations
has not been lost on those observers who, like the authors, seek with difficulty
to follow Chapter 11 developments.
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