Ontario Court of Appeal Upholds NAFTA Chapter 11 Award

Rajeev Sharma and Adam Goodman
February 04, 2005
On January 11, 2005, the Ontario Court of Appeal issued a judgment in the case involving the United Mexican States (Mexico) and Marvin Feldman Karpa (Feldman).[1]Justice Robert Armstrong of the Ontario Court of Appeal upheld Justice Dan Chilcott's decision of the Ontario Superior Court of Justice.[2] Justice Armstrong accepted Justice Chilcott's finding that the NAFTA Tribunal's US$1.6 million ruling against Mexico[3] should be given a high degree of deference and that Mexico had not shown any basis upon which to interfere with the arbitration award.
The Facts
The original NAFTA arbitration concerned Mexico's taxation of the business activities of US citizen Marvin Feldman, the sole owner of the Mexican-incorporated Corporación de Exportaciones Mexicanas S.A. de C.V. (CEMSA).
From 1990 to 1991, CEMSA exported cigarettes purchased from high-volume retailers in Mexico, such as Wal-Mart and Sam's Club, for resale in the United States. During that time, CEMSA enjoyed an excise tax rebate on its cigarette exports. In 1991, Mexico passed legislation eliminating tax rebates for cigarette exporters, which CEMSA and other exporters successfully challenged in Mexico's Supreme Court of Justice as discriminatory. In 1992, the legislation was amended to extend rebates to cigarette exporters once again. CEMSA took advantage of the rebate until 1993, when Mexican authorities denied it certain rebates, citing technical problems with CEMSA's invoices.
Mexico took the position that CEMSA was required to produce invoices from its vendors that expressly stated the amount of tax included in the purchase price. Because the tax authorities did not require vendors like Wal-Mart and Sam's Club to separate their taxes in their receipts -- despite Mexican law mandating them to do so -- CEMSA could not produce the invoices as required. This requirement made it impossible for CEMSA to take advantage of the tax rebate while other domestic companies, according to Feldman, continued to get the same rebates without being required to separate the tax and purchase price on their invoices.
In 1996, under pressure from the United States, Mexican authorities allowed CEMSA to separate the tax itself, permitting it to take advantage of the tax rebate once more. However, in 1997, the authorities again denied CEMSA's rebate applications and the legislation was changed yet again, eliminating the rebate for exporters. Feldman claimed unfair discrimination.
The NAFTA Chapter 11 Arbitration
Feldman sought US$50 million in damages, alleging that through these actions, Mexico had violated three key provisions of NAFTA Chapter 11:
Article 1102 (national treatment), the non-discrimination provision which guarantees foreign investors treatment the same as or better than that provided to local competitors;
Article 1105 (minimum standard of treatment), which guarantees "fair and equitable treatment" to foreign investors; and
Article 1110, which prohibits expropriation of a foreign investor's property without compensation.
During the arbitral proceedings, Mexico refused to produce tax records of Mexican competitors requested by Feldman, citing domestic privacy legislation. Mexico admitted, however, that five cigarette marketing companies had applied for the tax rebates and three had been granted them.
On December 16, 2002, the NAFTA Tribunal, composed of Prof. Konstantinos Kerameus, Jorge Covarrubias Bravo and David Gantz, issued its final award in the matter. While the Tribunal found no expropriation by Mexico under Article 1110, the majority did find that Mexico discriminated against Feldman vis-à-vis its domestic competitors, in breach of Article 1102. The arbitrators found they had no jurisdiction to consider Article 1105 because the dispute concerned taxation, a subject matter specifically excluded from challenge under NAFTA's Investment Chapter. As a remedy for the discrimination, they awarded Feldman approximately US$1.6 million in damages for the lost tax rebates.
In dissent, arbitrator Bravo found no discrimination on Mexico's part and would have awarded Feldman no damages.[4]
Judicial Review by the Ontario Superior Court of Justice
Because Ottawa was the seat of arbitration, Mexico brought an application to set aside the NAFTA arbitration award before the Ontario Superior Court of Justice pursuant to the International Commercial Arbitration Act (ICAA). The ICAA provides, inter alia, for limited recourse in setting aside arbitral awards if, for example, the award dealt with a subject matter that was not contemplated by the terms of the submission to arbitration or the award conflicted with public policy. Mexico made the following general arguments in support of its application to set aside the award:
The Tribunal drew impermissible inferences from Mexico?s compliance with its own taxation and privacy laws (i.e. the fact that Mexico did not produce the tax information of Feldman?s competitors should not have given rise to an inference of discrimination);
The arbitral procedure employed by the Tribunal when it drew a negative inference from Mexico?s refusal to produce tax records violated the agreement between the parties, procedural rules under NAFTA and in particular NAFTA Article 2105, which allows signatories to withhold information that impedes law enforcement or violates privacy laws; [5] and
Because the Tribunal accepted that Feldman was not legally entitled to the tax rebates, the award of damages was contrary to public policy.
As intervener before Justice Chilcott, the Government of Canada supported Mexico's position that NAFTA Article 2105 allowed Mexico to refuse the production of the tax receipts because they violated domestic privacy law. But, as was pointed out by Justice Chilcott, Mexico failed to raise this objection before the NAFTA Tribunal during the arbitration and therefore could not do so at the judicial review stage.
After extensively quoting the Tribuna's finding of facts in the award and emphasizing the expertise of the Tribunal, Justice Chilcott dismissed all three of Mexico's arguments. In upholding the Tribunal's findings, Justice Chilcott noted that arbitral awards should be accorded a "high level of deference."  In rejecting Mexico's public policy argument, Justice Chilcott emphasized that international arbitral awards should only be vacated on the basis of being against public policy in the most egregious of circumstances, which were not present in this case.
The Ontario Court of Appeal
In his discussion of the standard of review to be applied, Justice Armstrong emphasized the clear policy adopted by Canadian legislatures and courts to defer to international commercial arbitration awards. Quoting the Supreme Court of Canada's decision in Pushpanathan,[6] he listed four criteria that need to be taken into account in determining the level of deference to be accorded an international arbitral award on judicial review:
The presence or absence of a privative clause, purporting to exclude judicial review;
The expertise of the tribunal;
The purpose of the applicable legislation; and
Whether the issue under review is a question of law or fact.
Applying these criteria, as well as Feldman's argument that the entire purpose of NAFTA Chapter 11 is to remove dispute settlement from domestic courts to neutral international tribunals, Justice Armstrong concluded that the standard of review was one of high judicial deference.
Justice Armstrong subsequently accepted Mexico's argument that if the Tribunal had no authority to compel it to disclose taxpayer information, it was unacceptable to draw an adverse inference from its refusal to produce those records. But because Mexico had produced some evidence on the issue, Justice Armstrong held that Mexico opened itself up for the Tribunal to make an adverse inference in this case.
Most interesting was Justice Armstrong's discussion of Mexico's "public policy" argument. Justice Armstrong dismissed this argument in its entirety by applying the case of Corporacion Transnacional de Inversiones,[7] where the Ontario Court of Appeal noted that an arbitral award could be overturned on public policy grounds only if it "offends our local principles of justice and fairness in a fundamental way." Justice Armstrong concluded that there was nothing unjust or unfair about the Tribunal's award of damages, which he characterized as "the quantification of harm caused to CEMSA by the discriminatory conduct."
The Feldman case was the second NAFTA Chapter 11 award to completely survive the scrutiny of judicial review in Canada. As in the S.D. Myers case, the reviewing court found no reason to interfere with any aspect of the Tribunal's award.[8] However, Feldman is the only case to reach an appellate level court. The Ontario Court of Appeal is considered Canada's second-most influential judicial body after the Supreme Court of Canada. Its confirmation of the NAFTA Tribunal's award in this case supports the sanctity of NAFTA's investor-state arbitration process and its resultant awards.
In addition, Justice Armstrong's disposal of Mexico's public policy argument was telling. Under his reasoning, the award, and indeed the entire NAFTA Chapter 11 dispute settlement process, does not offend any reasonable notion of public policy. Indeed, by mandating signatory states to pay damages if they cause harm to foreign investors, NAFTA Chapter 11 forces Canada, the United States and Mexico to live up to the highest level of public policy -- the rule of law.
About the authors:
Rajeev Sharma practices international trade, international arbitration and competition law at Heenan Blaikie LLP in Toronto, Ontario. Mr. Sharma has been counsel on numerous NAFTA Chapter 11 arbitrations, as well as under various bilateral investment treaties under the ICSID and UNCITRAL rules.
Adam Goodman is an articling student at Heenan Blaikie LLP in Toronto, Ontario. He was formerly a trade policy analyst at the Department of Foreign Affairs and International Trade in Ottawa.
[1] Mexico v. Karpa, [2005] O.J. No. 16 (C.A.).
[2] Mexico v. Karpa, [2003] O.J. No. 5070 (S.C.J.).
[3] Feldman v. Mexico (2002), ARB(AF)/99/1 (Ch. 11 Panel), online: Department of Foreign Affairs and International Trade .
[4] Feldman v. Mexico (2002), ARB(AF)/88/1 (Ch. 11 Panel, Dissenting Opinion), online: Department of Foreign Affairs and International Trade < http://www.dfait-maeci.gc.ca/tna-nac/documents/Dissentingopinion.pdf>.
[5] NAFTA Article 2105 provides as follows: "Nothing in this Agreement shall be construed to require a Party to furnish or allow access to information the disclosure of which would impede law enforcement or would be contrary to the Party's law protecting personal privacy or the financial affairs and accounts of individual customers of financial institutions."
[6] Pushpanathan v. Canada (Minister of Citizenship and Immigration), [1998] 1 S.C.R. 982.
[7] Corporacion Transnacional de Inversiones S.A. v. STET International S.p.A. (2000) 49 O.R. (3d) 414 (C.A.).
[8] While the British Columbia Supreme Court upheld part of the NAFTA Chapter 11 award in Mexico v. Metalclad, 2001 BCSC 664, it also set aside a portion of it.