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The Sun Has Finally Set on NAFTA: Investor-State Arbitration Under the USMCA

The Sun Has Finally Set on NAFTA: Investor-State Arbitration Under the USMCA

By Andrew S. Hicks and Fatima Aslam

On July 1, 2020, the United States-Mexico-Canada Agreement (USMCA) took effect, replacing the 1994 North American Free Trade Agreement (NAFTA). The USMCA provides a three-year sunset period for investors to submit arbitration claims related to foreign investments established or acquired under NAFTA.[1]

Although the sunset period does not end until July 1, 2023, investors must submit a notice of intent to the host State at least 90 days before initiating an arbitration, meaning the practical deadline to file a NAFTA legacy claim was April 1, 2023.[2]  With this deadline now passed, investors can no longer access NAFTA’s dispute resolution mechanism and must file any investment claim under the USMCA regime.

The USMCA introduces substantial changes that restrict an investor’s right to seek arbitration as a remedy. Consequently, investors should be aware of the following three key distinctions between the USMCA and NAFTA:

1. Canada’s non-signatory status: Canada did not sign Chapter 14 of the USMCA, the section dealing with investor-state dispute mechanisms. As a result, investment arbitration is not available for U.S. and Mexican investors against Canada, nor for Canadian investors against the U.S. and Mexico. Although Canadian and Mexican investors can still arbitrate certain disputes under the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), to which both countries are signatories, the expiration of the NAFTA sunset period marked the end of arbitration opportunities for Canadian investors in the U.S. and vice versa.

2. Procedural limitations: Under Chapter 14 of the USMCA, before an investor can seek international arbitration, they must first exhaust all available legal remedies within the host State’s national court system. This means that they must either:

  • Obtain a final decision from the highest court in the host State, usually requiring appeals in multiple levels of the court system; or
  • Wait for a period of 30 months from the initiation of the legal proceedings in the host State’s courts, even if they have not rendered a final decision.[3]

This exhaustion of local remedies requirement is intended to give the host State’s courts an opportunity to address the dispute before an investor can resort to international arbitration.

3. Substantive limitations: The USMCA narrows the types of claims that investors can bring to arbitration. Under the agreement, investors can only submit claims to arbitration for:

  • Direct expropriation: This occurs when the host State directly seizes or nationalizes an investor’s property without providing adequate compensation.[4]
  • Violations of national-treatment and most-favored-nation obligations: These obligations require the host State to treat foreign investors from USMCA member countries no less favorably than their own domestic investors (national treatment) or investors from other countries (most-favored-nation treatment). Both obligations aim to prevent discriminatory treatment in favor of the host State’s nationals or other foreign investors.[5]

Notably, unlike under NAFTA, investors cannot submit claims to arbitration under the USMCA for:

  • Indirect expropriation: This happens when the host State’s actions, such as new regulations or policy changes, indirectly devalue or diminish the value of an investor’s property, even though the property is not directly seized.
  • Violations of the minimum standard of treatment: This standard requires the host State to provide foreign investors with a basic level of protection, including fair and equitable treatment, full protection and security, and protection against arbitrary or discriminatory actions.

Nevertheless, the USMCA provides investors with an opportunity to seek arbitration for breaches of all substantive investment protections, including indirect expropriation and minimum standard of treatment violations, if the investor is (i) a party to a covered government contract[6] and (ii) engaged in activities in a covered sector.[7]  The covered sectors include oil and natural gas, power generation, telecommunications, transportation, and infrastructure.[8] For investors that hold covered government contracts, there is no requirement to exhaust local remedies before initiating arbitration proceedings.

Because the USMCA significantly alters the landscape for investment arbitration, it is important for investors to take stock of these changes and consider their impact. In particular, U.S. investors with investments in Canada and Canadian investors with investments in the U.S. will no longer have access to investor-state arbitration now that the April 1, 2023, deadline for filing NAFTA legacy claims has expired.   Further, for those investors without a covered government contract, the availability of arbitration as a remedy will be far more limited than it was under NAFTA.

Andy Hicks is the managing partner and Fatima Aslam is an associate at Hicks Johnson PLLC, a Houston-based trial law firm.

[1] See USMCA Annex 14-C, Article 14.C.3.

[2] See NAFTA Article 1119.

[3] See USMCA Annex 14-D, Article 14.D.5.

[4] See USMCA Annex 14-D, Article 14.D.3.

[5] Ibid.

[6] USMCA Annex 14-E, Article 14.E.6 defines “covered government contract” as a written agreement between a national authority of an Annex Party and a covered investment or investor of the other Annex Party, on which the covered investment or investor relies in establishing or acquiring a covered investment other than the written agreement itself, that grants rights to the covered investment or investor in a covered sector.

[7] See USMCA Annex 14-E, Article 14.E.2.

[8] See USMCA Annex 14-E, Article 14.E.6.