The recently announced $130 million settlement by the Canadian government of the claim made by AbitibiBowater Inc. (“AbitibiBowater”), based on the investment chapter of the North American Free Trade Agreement (“NAFTA Chapter 11”), concerning legislation passed by the Province of Newfoundland and Labrador to expropriate its assets in that province, shows that such harmful measures can be imposed not only by governments in emerging market countries but also in highly developed economies.

This case is one of the growing number of investment disputes worldwide, and provides a cautionary reminder that Canadian investors forging into foreign markets will need to develop in advance an investment strategy that will enable them to have access to neutral international dispute resolution procedures in the event of egregious behaviour by any one level of government in the country in which they are investing.

As is also discussed below, increasingly, any investment strategy for foreign investment will also have to take into account legal obligations related to ethical and socially responsible behaviour.

Frequent use of investor-state arbitration procedures

The settlement with AbitibiBowater is not the first time that Canada has brought to an early end a NAFTA Chapter 11 case initiated by an investor from the United States without proceeding to a full hearing under the investor-state arbitration procedures provided within that free trade agreement. The first such settlement occurred in July 1998, within four years of the coming into effect of NAFTA, and related to a claim of regulatory expropriation arising out of an import and inter-provincial transportation ban against a gasoline additive manufactured by Ethyl Corporation (“Ethyl”).

Chapter 11 of NAFTA, which provided AbitibiBowater and Ethyl the basis for asserting their claims, has to date been relied upon for 28 challenges against Canada, followed by 15 and 11 challenges against Mexico and the United States, respectively.

On an international basis, Canada currently ranks among the top five defendants in such investment arbitration cases, in the company of Argentina, Mexico, Czech Republic and Ecuador. While the U.S. is not among the top five, it ranks a close six in such claims tied with Ukraine, and followed by Venezuela, Egypt, Poland and India rounding off the top ten.

Recent statistics from the International Centre for Settlement of Investment Disputes (“ICSID”) confirm that foreign investors are now increasingly willing to launch arbitration proceedings arising out of investment disputes based on adverse actions taken by foreign states, and the number of such claims has remained high since the year 2002. The surge of cases began in that year following the financial crisis in Argentina due to certain measures taken by its government against foreign investors in the midst of the crisis. Furthermore, socialist and nationalist policies recently being pursued by other governments in South America, Eastern Europe, and Central Asia have provided the grounds for several arbitration cases, including by Canadian investors investing in those countries in the financial services sector, oil and gas, and mining industries.

The most frequently used instruments for such claims are foreign investment promotion and protection agreements (also known as bilateral investment treaties) which account for 63 percent of such claims (now numbering in excess of 350 and rapidly growing), followed by arbitration clauses contained within investment contracts entered into between investors and host states (accounting for 22 percent of the total claims), and investment laws of the host state (which account for 5 percent of such claims). Investors in the energy sector are also resorting to the Energy Charter and its arbitration mechanism. The Energy Charter, which became effective in 1998, was designed to govern energy investment and trade between the western European states and the countries that emerged as independent states from the collapse of the Soviet Union.

The financial and energy sectors are providing the basis for some of the largest claims, measuring in the billions of dollars.

Local and community action can harm foreign investors’ expectations

The AbitibiBowater case also further demonstrates that any assessment of potential harm to current and future foreign investments should include the possibility of adverse actions that can be taken by all levels of governments, including at the provincial and municipal levels. There are numerous examples in the area of foreign investment disputes where local communities and other non-governmental organizations have been instrumental in causing a reversal of representations and promises made by the national level of government, with the result that existing and future plans by foreign investors have been brought to a standstill. Foreign investors therefore have to pay heed not only to policies and tendencies of the national governments, but also local politics and interests of municipal governments as well as communities in which they invest. For example, in the case of AbitibiBowater, the expropriation measures taken by the government of that province, although at odds with the federal government’s commitments under NAFTA, were fully supported at the local community level.

In the context of Canadian businesses venturing into North American markets, and increasingly overseas, it is therefore critical for senior management to understand and appreciate the potential for such local and community based risks, and to develop long term plans to ward off adverse reaction to their investments from such quarters. Socially responsible and ethical corporate behaviour (including avoidance of corrupt practices based on documented compliance programs) are now critical legal elements in the development of a sound foreign investment strategy. (See: Investing in Ethical Corporate Culture: The Imperative for Instituting an Anti-Corruption Compliance Program for Canadian Businesses Venturing Overseas)

This is particularly the case for Canadian companies involved in economic sectors where investments are made with a long term expectation of return, and regulatory oversight from governments tends to be high, such as financial services, oil and gas, mining, electrical power and other energy, airport construction and other infrastructure projects (such as water, sanitation and other municipal projects), and hotel and resort projects. Furthermore, such projects require a high level of interaction with government officials at all levels, and often have significant consequences for the local communities -- both positive and negative -- that need to be carefully managed.

Investment protection and Canadian investors

Canadian investors are now able to resort to making investment protection claims based not only on the approximately two dozen foreign investment promotion or protection agreements concluded by Canada, but also one of more than 2,700 bilateral investment treaties that have been negotiated worldwide (provided they have utilized forward planning techniques by channelling their investments into a host country in a manner so as to take advantage one of these investment treaties). (See:Canada Revitalizes Program of Bilateral Trade and Investment Initiatives) While at the beginning of the 1990s there were approximately 300 bilateral investment treaties worldwide, their number now exceeds the number of double taxation treaties negotiated worldwide.

Notwithstanding the increasing number of known investor claims arising out of bilateral investment treaties, many emerging market countries continue to enter into such investment protection treaties, including with Canada, knowing that long term investors base their investment strategies on the expectation that host countries will respect the rule of law, provide transparency, avoid engaging in discriminatory or arbitrary conduct, not engage in either outright expropriation or “creeping” expropriation without full compensation, permit full management of their business without government interference, allow management personnel to travel and reside in the host countries, afford full protection to their personnel and property, and ultimately facilitate repatriation of revenues and capital derived from their business ventures.

Reasons why governments settle claims

In entering into the settlement agreement with AbitibiBowater for actions taken by the Government of Newfoundland and Labrador, the Canadian government indicated that its “approach reaffirms the Government of Canada’s commitment to maintain a rules-based business environment that facilitates free trade and encourages investment.” In making this statement and paying compensation, the government correctly took into account the expectations of Canadian businesses venturing abroad that foreign host countries should also provide reparations when taking measures that harm their investments, even if such measures are short of outright expropriations or nationalizations.

In agreeing, in appropriate cases, to settle claims brought by foreign investors, Canada is not alone, as even the most ardent socialist and nationalist governments have realized that in globalized markets investments flow into countries that respect the rule of law. Within days of the August 24, 2010 announcement by Canada of the settlement of the AbitibiBowater claim, the Government of Venezuela confirmed on September 13, 2010 that it would pay the Swiss cement giant Holcim Group (“Holcim”) $650 million U.S., with an immediate down payment of $260 million, and the remaining amount payable in four annual instalments. These settlement negotiations were engaged in by Venezuela to ward off an international arbitration proceeding filed by Holcim, the second largest cement producer in the world, under the ICSID rules.

Advance planning key to successful investment strategies

Canadian investors making foreign investments, whether in the United States, Mexico, or beyond the shores of North America, now have at their disposal various international investment and trade rules that can assist in proper planning and when necessary permit resort to dispute resolution, through investor-state arbitrations or government-to-government processes (such as exist under the WTO, regional agreements such as under NAFTA, or bilateral trade and investment agreements). (See: Canadian Businesses Urged to Adopt Strategic Policy Measures in Face of Flagging Doha Round Negotiations)

Access to such rules requires in some cases advance planning as well as responsible investing, taking into account the growing legal obligations for foreign investors to act ethically and in a social responsible manner so as to ensure that their claims are sympathetically heard when advanced under the applicable domestic and international rules.