Rethinking Custom

The fair and equitable treatment (‘FET’) is a prominent protection granted to a foreign investor under investment treaties. This post focuses on the formulation of FET under Article 1105 of the North American Free Trade Agreement (‘NAFTA’), which links FET with the customary international minimum standard of treatment (‘MST’). Previously, it has been argued that Article 1105 has been interpreted restrictively. This post advances a different evaluation: the MST-FET linkage is structurally problematic because it enables the elevation of elements of the autonomous FET to custom without establishing the requirements of state practice and opinio juris.

The analysis is relevant despite NAFTA’s replacement by the United States-Mexico-Canada Agreement (‘USMCA’) for three important reasons. Firstly, legacy claims still proceed under the USMCA’s three-year sunset clause in Annex 14-C. Secondly, a number of subsisting treaties, including the Comprehensive Economic and Trade Agreement (‘CETA’), the US Model Bilateral Investment Treaty (‘BIT’)and several BITs of NAFTA countries retain the MST-linked FET formulation. Lastly, the NAFTA’s interpretive approach has percolated non-NAFTA disputes. Rather than rehearsing whether the expansive interpretation is doctrinally correct, this post asks two further questions: whether the form of argument tribunals use to bridge MST and FET is supportable and the resulting institutional consequences when tribunals act as creators rather than recognizers of custom.

Minimum Standard of Treatment & Fair and Equitable Treatment: A Brief Background

MST was conceived as a human rights standard of protection granted to aliens. Neer v. Mexico articulated the breach of MST as “…should amount to an outrage, to bad faith, to wilful neglect of duty, or to an insufficiency of governmental action so far short of international standards that every reasonable and impartial man would readily recognize its insufficiency”. It was adopted by Western States to ensure a level of protection to their nationals abroad since the existing standard of protection was considered to be low. As a result, the threshold for establishing its breach remains high. Importantly, the MST is recognized as a rule of customary international law. A limited set of obligations on host States to: prevent the denial of justice in the administration of justice, provide due process, prevent arbitrary conduct and provide investors with ‘full protection and security’, are considered to be a part of the MST.

Unlike the MST, the FET is a treaty-based standard that emerged because of the rejection of the former by developing States. By the time of the rejection, the MST had already developed as a rule of custom. However, Western States introduced FET in their treaties with developing States, intending it to be different from and more exacting than the MST. The use of ‘fair’ and ‘equitable’ has allowed tribunals to interpret the standard broadly to include the protection of legitimate expectations, good faith, transparency, consistency and due process. This broad ambit of the standard corresponds with the relatively lower threshold required to establish its breach.

Emergence of the Expansive Approach

Through the linkage of both standards, the scope of Article 1105 was intended to be limited to include those  investor protection standards that have become a rule of custom. However, the interpretations in Metalclad v. Mexico, S.D. Myers v. Canada and Pope & Talbot v. Canada had led to considerable confusion. Metalclad introduced transparency, an element from the autonomous FET standard within the scope of Article 1105 without establishing that it was custom. S.D. Myers held that a breach of the national treatment provision would lead to a breach of Article 1105 while the Pope & Talbot adopted the additive character interpretation, which offered an investor the protection of the MST plus the FET. To limit this expansion, the Free Trade Commission (‘FTC’) issued a binding Note of Interpretation in 2001. This Note clarified that Article 1105’s reference to international law should be construed to mean that FET does not require treatment in addition to or beyond that which is required by the customary MST. However, tribunals were able to circumvent this as well.

In its post-Note award, the Pope & Talbot tribunal upheld its pre-Note award despite it being directly overruled. The tribunal held that there had been an evolution in customary international law since the time when Neer was decided. This evolution had taken place to the extent where the FET was now considered to be a part of the customary MST. This interpretation of the tribunal was followed by subsequent tribunals in Mondev v. USA, ADF v. Canada and Merrill & Ring v. Canada. The issue was that none of the tribunals had established the basis of this finding of ‘evolution’ of custom.

However, this picture is not uniform. Glamis Gold v. USA adopted a more deferential stance towards the FTC Note. The tribunal placed the burden of demonstrating the evolution of custom on the party asserting the change. After finding the burden unmet in the case, it retained the fundamentals of the Neer standard to establish the violation of Article 1105. As a result, Glamis drew a distinction between evolution in what conduct is considered outrageous and evolution in the legal standard itself, which requires fresh evidence of customary formation. The tribunal focused on the former. This post endorses that approach because it accommodates contemporary state action without sacrificing the legal-conceptual basis of the MST. None of this is to suggest that the post-Note evolutionary turn produced uniform harm at the outset. As Dumberry has shown, the evolutionary approach adopted by the tribunals post-the Note had no practical impact on the outcome of these cases in terms of liability as the respondent States were not found to be responsible for any breaches of Article 1105 under this approach. The concern is what followed. Later tribunals lowered the threshold of liability by importing the standards from autonomous FET case-law and, unlike their predecessors, did so to ground actual findings of breach.

This is evident from the decisions of Bilcon v. Canada and Eco Oro v. Colombia. As per Bilcon, there is a high threshold for the conduct of a host state to rise to the level of a NAFTA Article 1105 breach, but there is no requirement in all cases that the challenged conduct reaches the level of shocking or outrageous behavior.  Based on this less stringent standard, the tribunal found Canada to be in breach of Article 1105 as it had breached the legitimate expectations of the investor. The protection of legitimate expectations is a part of the autonomous FET standard and not the MST. So, Article 1105’s protection ambit was stretched to include the protection of legitimate expectations. This normative elevation of autonomous FET to custom percolated non-NAFTA MST-linked FET clauses’ interpretation as can be seen in Eco Oro. This case arose under the Canada-Colombia Free Trade Agreement, whose FET clause is identical to that of the US Model BIT. Despite the FTC Note’s obvious influence on the FET standard in the US Model BIT, the Eco Oro majority tribunal followed the post-Note expansive approach to hold Colombia’s actions as frustrative of the investor’s legitimate expectations. This was considered to be a breach of the MST-linked FET standard of the treaty.

Therefore, we can see that the expansive approach has influenced the practical outcome of cases as it has lowered the threshold for establishing a breach of the standard and included elements from the autonomous FET standard into the qualified standard without establishing the fulfilment of the twin conditions of state practice and opinio juris. There are institutional implications of such an approach as highlighted below.

Institutional Implications of the Expansive Approach

As per Schill, FET is a “general clause” that de facto delegates substantial rule making power to tribunals to ascertain its meaning. This is indicative of a deliberate shift in the power of norm generation from States to the tribunals, which converts arbitrators into legislators for the entire system of international investment law. However, this shift in power does not accord tribunals unlimited discretion in interpreting the treaty, especially when the treaty refers to a customary international law standard. This is because tribunals cannot create custom. They can only recognize it. The NAFTA experience has been to the contrary as tribunals have not undertaken this recognition, instead they have normatively elevated elements to custom through the MST. This has influenced State behavior as reflected in treaties. Now, States have started enacting specific prohibitions in treaties to limit the interpretative scope of tribunals. For instance, Article 14.6 (4) of the USMCA clearly states that a breach of the legitimate expectations of the investor will not constitute a breach of the MST-linked FET standard. This is in direct response to the tribunals’ inclusion of legitimate expectations from the FET to Article 1105’s scope.

This negatively impacts developing countries. As per an empirical analysis, it has been observed that developed countries generally incorporate elements identified by tribunals more frequently than developing countries do. This is owing to the latter’s limited institutional-legal capacity. This limitation is now exacerbated as treaties have become the only avenue to limit the scope of tribunals in interpreting the FET. In other words, this trend of States resorting to treaties as a response to the expansive approach will burden the institutional-legal capacity of developing countries as it would require proactivity in interpreting and incorporating changes to the standard in the treaties. This calls for tribunals’ methodological adherence to their role of recognizing custom rather than declaring it through expansive treaty interpretations.