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Metalclad v. Mexico

I met with Mr. Grant Kesler, the owner of Metalclad. I talked very clearly with him, saying that it was, from my point of view, virtually impossible to open the site due to the opposition of the local community and the local authorities. And he said, no, no, no, it will take a lot of time, but… I have the federal permit in order to do so. And I say, well, it’s not enough.”

--Hon. Horacio Sanchez Unzueta       
                 (Governor
of San Luis Potosi 1993-97)


”In the NAFTA tribunal decision Metalclad v. Mexico, Mexican state and local officials used their authority over land use regulation to stop a U.S. multinational from operating a hazardous waste disposal facility located on top of an aquifer providing drinking water to a town in the state of San Luis Potosi. Metalclad then brought a suit against Mexico under NAFTA’s Chapter 11 on investment, claiming that the company’s property rights had been violated. A NAFTA tribunal, meeting in secret as is the custom in international arbitration, agreed that Metalclad’s rights had been violated and ordered the Mexican national government to pay several millions of dollars in damages.”
—Hon. Bev Perry (Mayor of Brea California, 2001)

Metalclad v. Mexico is a landmark case, which found that local land use and environmental regulation violated international property rights protections, based on a broad reading of NAFTA investor protections and an unwillingness to defer to local courts.

  • Why is Metalclad relevant to U.S. states and localities?
  • What were the facts in Metalclad?
  • What is the history of the Metalclad proceedings?
  • What was the basis for the tribunal and appellate court decisions?
  • What are the legal and policy implications of the Metalclad decision?

Why is Metalclad relevant to U.S. states and localities?
Imagine the following hypothetical case. Hazmat Global, a Canadian corporation, wants to invest in South Carolina. Hazmat is encouraged by officials at the U.S. Department of Commerce to open a hazardous waste disposal facility near Hilton Head, South Carolina. The feds tell Hazmat executives that South Carolina is the perfect site, and that the concerns of state and local authorities can be ‘taken care of.’ Hazmat invests $20 million in the site.

Hilton Head residents are furious. The proposed Hazmat plant site is located on top of an aquifer from which local residents draw their drinking water. Public meetings are held. The local land use board denies the permit needed to open the plant.

Attorneys for the U.S. Department of Commerce assure Hazmat that the local land use board has acted illegally and that Hazmat should just go ahead with the project. Local officials and the South Carolina Attorney General seek an injunction to stop the company from opening the plant. A South Carolina state court issues the injunction.

Hazmat then sues the United States under the investment chapter of the North American Free Trade Agreement (NAFTA). Hazmat seeks $50 million in compensation for the actions of the local land use board and the South Carolina court.

An international tribunal is constituted under the auspices of a unit of the World Bank to hear Hazmat’s claims against the United States. Under World Bank rules the proceedings are largely held in private. After two years of deliberations, the tribunal awards Hazmat $30 million. The tribunal finds that the local land use board and the South Carolina court expropriated Hazmat’s property and failed to satisfy standards of minimum treatment for foreign investors under international law.

Is this hypothetical example far fetched? No—this example follows the basic fact pattern of the Metalclad case.

What were the facts in Metalclad?
This dispute arose over the use of a plot of land, located near the municipality of Guadalcazar, in the state of San Luis Potosi, Mexico. This plot of land was originally owned originally by a Mexican company, COTERIN. In 1990, the Mexican federal government granted COTERIN a permit to build and operate a hazardous waste landfill on the land. Thereafter, COTERIN applied to the municipality of Guadalcazar for a building permit to construct the landfill. In both 1991 and 1992, the municipality denied COTERIN such a building permit. Despite the municipality’s denial, in 1993 COTERIN received three building permits to construct and operate the landfill: two from the Mexican federal government’s Secretariat of the Environment, and one land use permit from the state government of San Luis Potosi. But COTERIN still had not received a municipal building permit.

In 1993 the U.S. corporation Metalclad contracted for an option to buy COTERIN and its permits. Then—after receiving assurances from federal government officials as well as the Governor of San Luis Potosi that all necessary permits for the landfill had been obtained—and that the federal government would secure any further support required from the state of San Luis Potosi and the municipality of Guadalcazar—Metalclad purchased COTERIN, the landfill site, and COTERIN’s state and federal building permits.

Shortly after Metalclad purchased COTERIN, the Governor of San Luis Potosi publicly denounced the landfill project. Nevertheless, in May 1994, upon securing an extension of the federal building permit, Metalclad began construction of the landfill. Then, in October, 1994, the City of Guadalcazar ordered a halt to construction because Metalclad had not obtained proper municipal building permits. Federal officials advised Metalclad to apply for the municipal permit merely “to appease the municipality,” allegedly assuring Metalclad that Guadalcazar could not deny the permit. Metalclad therefore applied again for the municipal permit. Immediately thereafter Metalclad resumed construction, and in March 1995 completed the landfill building project.

That same month, Metalclad attempted to open its new facility for operations. But angry local protestors, allegedly with the aid of state troopers, blocked the opening of the new facility. The landfill remained closed until November 1995.

In November, Metalclad entered into an agreement with two federal agencies, and the facility began to operate. The Guadalcazar city council responded in December 1995 by denying Metalclad’s last petition for a municipal building permit. Allegedly, the city council acted without granting the Metalclad corporation any notice or opportunity to be heard.

Soon thereafter, Guadalcazar brought action against the federal government to challenge the agreement the federal agencies entered into with Metalclad. Pending resolution of this suit, Guadalcazar successfully obtained a preliminary injunction barring further operations at the landfill site. While the action was pending, the same federal agencies granted Metalclad a further permit which authorized a substantial expansion of the landfill site.

Finally, in September 1997, the Governor of San Luis Potosi issued a state-level decree which established the landfill site as a protected natural area. Thus, without any reference to the lack of a municipal building permit, the state government entirely prevented the landfill from operating.

History of the Metalclad proceedings
Nine months earlier, on January 2, 1997, Metalclad had already demanded arbitration under NAFTA’s Chapter 11. In its claim against the Mexican federal government, Metalclad argued that the nation of Mexico was responsible under international law for the conduct of its governmental subdivisions, and that both the state of San Luis Potosi and the municipality of Guadalcazar had violated NAFTA section 1105’s “ minimum treatment” standard, and NAFTA section 1110’s “expropriation” prohibition.

As provided for in NAFTA, Article 1120, Metalclad filed its Notice of Claim with the Additional Facility of the International Centre for Settlement of Investment Disputes (ICSID). On January 13, 1997, the Secretary-General of ICSID informed the parties that the requirements for accessing an ICSID tribunal had been fulfilled, and issued a Certificate of Registration of the Notice of Claim. On May 19, 1997 the ICSID Tribunal was constituted, and it held its first session on July 15, 1997.

After extensive review of Metalclad’s claims during a period of over three years, in August 2000 the ICSID Additional Facility tribunal issued a two-part decision: (1) Mexico’s conduct violated Article 1105(1) of NAFTA, which was intended to ensure the fairness, equity, and “transparency” of domestic investment rules for foreign investors, and (2) Mexico’s conduct was deemed to be “a measure tantamount to expropriation” under the language of NAFTA section 1110. For these two violations, the Tribunal found that Metalclad was entitled to monetary relief in the amount of $16.9 million from the nation of Mexico.

Following the August 2000 decision of the arbitration panel, Mexico sought domestic court review in the British Columbia Supreme Court. “Because the parties had designated the place of arbitration to be Vancouver, B.C., the International Commercial Arbitration Act allowed the Supreme Court of British Columbia to [have jurisdiction to] set aside the Tribunal’s award under certain limited circumstances”—should the proceeding move to that stage.

On May 2, 2001, the British Columbia Supreme Court resolved the question of whether the Metalclad tribunal had exceeded its authority under the B.C. international arbitration statute. The decision came down in favor of Metalclad, as the British Columbia Supreme Court agreed with the Tribunal that the Mexican federal government owed Metalclad nearly $16 million US dollars.

  • Specifically, in his British Columbia Supreme Court opinion, Judge Tysoe delivered a two-part decision which (1) agreed with the ICSID Tribunal’s finding that the decree passed by the State government of San Luis Potosi was an expropriation of Metalclad’s property; (2) agreed that compensation to Metalclad was thus required by the federal government of Mexico under NAFTA Chapter 11; and (3) disagreed with the Tribunal’s finding that the refusal of Guadalcazar to grant a municipal building permit was a violation of NAFTA obligations of “fair and equitable treatment” under article 1105(1) on minimum treatment under international law.and therefore also a violation of article 1110 on expropriation. (Judge Tysoe reached this conclusion because the violation alleged was based on the wrong section of NAFTA.)

Soon after the British Columbia court reached its result, the Mexican federal government announced that “Mexico's Ministry of the Economy has paid over $16 million U.S. dollars to the United States corporation Metalclad in order to comply with a ruling by a North American Free Trade Agreement (NAFTA) arbitration panel.”

In sum, following the NAFTA Tribunal decision and the British Columbia Supreme Court decision, the Mexican federal government was required to pay – and did pay – the full costs of the tribunal award.

The Tribunal decision
The Metalclad tribunal found that Mexican authorities had violated two important investor rights protected by NAFTA: article 1110 on expropriation and article 1105 on minimum treatment under international law.

  • Compensation for expropriation. NAFTA requires member nations to compensate investors if national or subnational governments “directly or indirectly nationalize or expropriate” an investment of the other countries' investors in its territory. Expropriation includes measures “tantamount to nationalization or expropriation.” The Metalclad tribunal had to decide not only the scope of expropriation, but also what the open-ended references to “tantamount to expropriation” and “indirect” expropriation meant.

    The Metalclad tribunal broadly read the term “tantamount to expropriation” and “indirect expropriation” in NAFTA’s article on expropriation. This broad reading granted to investors a set of property rights protections that extend beyond the protections granted to property owners under the Fifth Amendment to the U.S. Constitution.

    In interpreting the Fifth Amendment “takings” clause, the U.S. Supreme Court “usually has applied the regulatory takings analysis only to regulations of specific interests in property.” Expected or future economic benefits are not considered property under the Takings Clause. By way of contrast, the Metalclad tribunal read NAFTA’s expropriation article to include not merely the seizure of property or its regulation to the point that its economic value is extinguished, but also “covert or incidental interference with the use of property which has the effect of depriving the owner, in whole or significant part, of the use or reasonably-to-be-expected economic benefit of property…” In its Metalclad opinion, the “ tribunal made it clear…that the relevant ‘investment’ for purposes of its expropriation analysis was Metalclad’s broader interest in operating a particular type of business, not merely its interest in its real property.”

  • Minimum treatment under international law. NAFTA article 1105(1) requires member nations to provide other members' investors with treatment in accordance with customary international law, including fair and equitable treatment and full protection and security. Article 1105 is intended to serve roughly the same purpose as “due process” norms in U.S. constitutional law, but because article 1105’s terms are largely undefined, especially when compared with the extensive U.S. case law on procedural and substantive due process, international investment tribunals exercise great discretion when they make inherently subjective judgments about when government action violates fundamental principles of procedural or substantive justice.

    According to the Metalclad tribunal, Mexico breached article 1105(1) because it “failed to ensure a transparent and predictable framework for Metalclad’s business planning and investment.” The tribunal noted the lack of an “orderly process” in at least three circumstances:

    No clear rule or established practice:
    The tribunal concluded that Mexico did not accord Metalclad “fair and equitable treatment.” Fair and equitable treatment was understood to incorporate principles of transparency in NAFTA chapter 18, because there was no clear rule and no established practice with respect to whether Metalclad was required to obtain a municipal permit prior to constructing and operating its hazardous waste facility in San Luis Potosi.

    Detrimental reliance on assurances of federal officials: The tribunal similarly concluded that Mexico did not accord Metalclad “fair and equitable treatment” (as interpreted to require transparency and a predictable regulatory environment) because the company relied on representations of federal officials that a municipal permit was not required. But Guadalcazar officials later refused that permit. A finding that Mexico had failed to provide Metalclad with “fair and equitable treatment,” because of statements made by Mexican federal officials, would be an astonishing conclusion in a U.S. court—where businesses have an obligation to take due diligence in researching the laws and regulations that regulate their economic activities.

    Notice and opportunity to be heard
    : The tribunal finally concluded that Mexico did not accord Metalclad “fair and equitable treatment” because the municipality of Guadalcazar did not meet its obligation to conduct a transparent regulatory process, when it failed to give Metalclad adequate notice of the meeting where its construction permit application was denied and failed to provide adequate and credible reasons for denying the permit.

    Certainly, a U.S. court might find an authentic failure to provide notice and opportunity to be heard to be a violation of procedural due process. The question here is why the Metalclad panel felt competent to apply Mexican law and make its own findings of fact— rather than requiring Metalclad to pursue its claims using domestic judicial remedies.

  • The appellate court decision.  Because Metalclad v. Mexico was arbitrated under ICSID Additional Facility rules, domestic courts could review the tribunal decision. Those rules allow a party to ask the domestic courts at the “seat” of the arbitration, in this case British Columbia, to set aside an award because of a violation of that jurisdiction’s international arbitration statute. On this basis Mexico petitioned a British Columbia court to review the award in the Metalclad case to determine its conformity with the B.C. statute governing such arbitrations (which is based on the International Commercial Arbitration Act). The grounds for review under the B.C. statute are: improper constitution of the tribunal, actions taken beyond the jurisdiction of the tribunal, and violations of public policy.

    As noted above, the British Columbia Supreme Court in an opinion by Judge David Tysoe agreed with the Metalclad tribunal’s finding that the decree issued by the state government of San Luis Potosi, creating an ecological zone and barring Metalclad’s waste disposal facility from operating, was an expropriation of Metalclad’s property, but it disagreed with the tribunal’s findings that the refusal of City of Guadalcazar to grant a municipal building permit for the Metalclad facility was a denial of fair and equitable treatment under international law and an expropriation.

    Recall that the Metalclad tribunal interpreted the concept of “fair and equitable treatment” under article 1105(1) in light of the transparency requirements in NAFTA article 102(1), a section of the agreement not located in chapter 11 on investment, but in chapter 18 of the agreement. But, Metalclad’s right to arbitrate a claim against Mexico, Judge Tysoe reasoned, is confined to alleged breaches of obligations under section A of NAFTA chapter 11 and two articles found in chapter 15 and do not extend to the transparency obligation in chapter 18 (an obligation that might be the basis of state-to-state arbitration, but not investor-to-state arbitration). Therefore, Tysoe concluded that the Metalclad tribunal was acting beyond the scope of its authority to arbitrate under B.C. international arbitration act, because the tribunal found that the municipality of Guadalcazar—which required, but then refused to issue, a building permit—violated Mexico’s article 1105(1) obligation related to “fair and equitable treatment.” Also, the tribunal’s finding that Guadalcazar’s non-transparent permitting process amounted to an expropriation under article 1110, Tysoe concluded, was beyond the scope of its authority under the B.C. arbitration statute.

    In other words, the tribunal’s finding of an article 1110 expropriation violation was also beyond the scope of the tribunal’s authority under the B.C. statute because it was based entirely on the previous finding of an article 1105(1) violation that inappropriately incorporated transparency obligations from NAFTA chapter 18.

    Nonetheless, Judge Tysoe let stand the Metalclad tribunal’s finding that the ecological decree of the state of San Luis Potosi was a violation of article 1110 on expropriation, because that finding was based on neither a lack of transparency nor a flawed finding of an article 1105(1) violation.

Legal and policy implications of the Metalclad decisions State and local officials should be concerned about the Metalclad tribunal decision for at least three reasons:

  • A successful challenge to core functions of state and local government: The Metalclad case illustrates how NAFTA’s investment chapter allowed a transnational corporation to successfully bring a complaint based on state and local governments performance of core governmental functions: protecting public health and regulating land use.

  • A broad reading of NAFTA’s investor protection against expropriation: The Metalclad tribunal read article 1110 on expropriation very broadly to include “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 the property.” This broad reading of article 1110 would provide foreign investors with greater rights than U.S. investors in property enjoy under the U.S. regulatory takings doctrine. This broad reading would substantially diminish state and local regulatory authority related to land use and environmental protection. As the U.S. Supreme Court explained in its recent decision in Lingle v. Chevron 125 S. Ct. 2074 (2005), which rejected Chevron’s “takings” arguments, the touchstone of regulatory takings doctrine is “to identify regulatory actions that are functionally equivalent to the classic taking in which the government directly appropriates private property or ousts the owner from his domain.”

  • A broad reading of NAFTA investor protection related to minimum treatment under international law: The Metalclad panel’s finding that transparency requirements should be read into the concept of “fair and equitable treatment” parallels the expansive reading of the text of article 1105 by other NAFTA tribunals. For example, a NAFTA tribunal in Waste Management II concluded that “fair and equitable treatment” is violated by government conduct “leading to an outcome which offends judicial propriety—as might be the case with a manifest failure of natural justice in judicial proceedings or a complete lack of transparency and candor in an administrative process.” No responsible U.S. court would presume to divine natural law in this way.

The British Columbia court decision: State and local officials should not take too much heart from the decision of Judge Tysoe to set aside the Metalclad tribunal’s holding that the permitting process of the municipality of Guadalcazar and the final denial of a permit for Metalclad to operate its hazardous waste disposal facility violated NAFTA articles 1110 and 1105(1). State and local officials should still be concerned for three reasons.

  • General deference to the arbitral process: The British Columbia court conducted a relatively narrow and technical review of whether the Metalclad tribunal exceeded its authority under the B.C. international arbitration statute. It did not engage in any analysis of whether the fundamental structure and process of the investor-to-state dispute resolution process under NAFTA Chapter 11 comports with public policy, as it is authorized to do under the B.C. statute.

  • A guide for future tribunals. Judge Tysoe’s opinion provides a guidebook for future NAFTA tribunals to reach the same results as the Metalclad tribunal without making technical errors that could lead a reviewing court to set aside all or part of a tribunal award. In other words, future tribunals should not attempt to import Chapter 18 concepts of transparency into the article 1105(1) concept of fair and equitable treatment. Instead, they should rely on customary international law, as now required by the Free Trade Commission’s official interpretation of minimum treatment under international law.

  • The political blowback. Modest as it is, Judge Tysoe’s decision has produced political blowback. As part of the 2002 Trade Act, Congress directed the U.S. State Department to create a process for appellate review of international investment tribunal decisions. A current proposal for an appellate mechanism being circulated by the State Department would prohibit even limited domestic court review of international tribunal actions, and substitute in its place review by a second ad hoc international investment tribunal!

What’s next?
Metalclad v. Mexico is not the last word on all of these issues. The landmark decision of the tribunal in Methanex v. United Statestook a very different approach, in a similar case, at least with respect to the appropriate expropriation analysis. The Metanex tribunal’s decision is important because of its holding that, with some caveats, a non-discriminatory regulation for a public purpose, which is enacted with due process, cannot constitute an expropriation.

The hope is that future investment tribunals, as the Methanex tribunal attempted to do, will balance international investor rights with government’s need to regulate in the public interest. But, even if they narrowly read article 1110 on expropriation, future tribunals may still broadly interpret customary international law concepts of due process in the course of judging article 1105 claims of violations of minimum treatment under international law. In doing so, they may effectively undercut state and local government’s capacity to regulate in the public interest. Metalclad v. Mexico still stands as a warning.

 


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