On September 30, 2018, the United States, Mexico and Canada (the Parties) reached an agreement to replace the North American Free Trade Agreement (NAFTA). The new agreement is called the United States-Mexico-Canada Agreement (USMCA).  As has been widely reported, the Parties conducted many months of negotiations to reach this agreement.

It is important to note that the USMCA still has to be ratified by all the Parties.  Until this ratification has taken place, the current NAFTA rules and regulations remain in place. This means that there is no immediate change to existing legal structure in place.

One of the biggest changes in the USMCA is that it will displace (once it enters into force) and significantly alter the former NAFTA Chapter 11 – the investor-state dispute settlement (ISDS) system between the Parties. The USMCA essentially erases ISDS as between Canada and the US, curbs ISDS as between Mexico and the US, and leaves Canada and Mexico to the ISDS system in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).

One of the principal goals of ISDS is to provide protections for foreign investment by nationals and companies of one state in the territory of another state, in order to create a more predictable and possibly more favourable investment climate.

The curbing of ISDS in the USMCA reflects a larger trend of efforts to minimize investors’ ability to seek redress against governments for allegedly wrongful acts, such as expropriation.  This effort to curb ISDS has come from politicians of many different political views in a wide range of countries, from Australia to Venezuela.[1]

ISDS between Canada and the US

After the USMCA enters into force, Canadian investors in the US and US investors in Canada will not be able to commence neutral arbitration proceedings against the state Parties in which they have invested. Instead, if one of the state Parties has breached a substantive right of the investor under Chapter 14 of the USMCA (i.e., expropriated its investment) the investor will have to rely on bringing a claim in the national courts of the host state (i.e., where the investment was made).[2]  The investors will therefore have to rely on the national courts host state to remedy any alleged violations of Chapter 14.

Under Annex 14-C, claims with respect to investments established or acquired while NAFTA is still in effect (“legacy investments”) will remain in place until three years after the termination of NAFTA. This means that US or Canadian investors who have invested in the other state prior to the termination of NAFTA (which could be months or years away) will be entitled to the protections of NAFTA (including the right to arbitration) for three years following its termination.  The key here is that the investment would have to be made prior to the termination of NAFTA.  Once NAFTA is terminated, any investments made after that date – even if made in the three year sunset period – will not be susceptible to arbitration.

Although this “sunset clause” is notably shorter than most other investment treaty sunset or survival clauses,[3] the three-year sunset provision makes sense in light NAFTA’s “statute of limitations,” which prevents claims from being brought more than three-years after the offending act.  In other words, any alleged wrongs that occurred more than three-years after the termination of NAFTA could not be brought under NAFTA in any event.

While the USMCA Chapter 14 is a step backwards for American and Canadian investors, Canada will likely see this new deal as a win. Canada has been sued 41 times under NAFTA Chapter 11, more than Mexico or the US. While the US has never lost a case under NAFTA Chapter 11, Canada has lost eight and won nine. It is estimated that Canada has paid out more than $219 million in damages and settlements under NAFTA and has spent $95 million in unrecoverable legal costs.[4]

ISDS between Mexico and the US

Under Annexes 14-C, 14-D and 14-E of the USMCA, US investors in Mexico and Mexican investors in the US can still commence arbitrations against the state in which they invested.

As with Canada and the US, Mexican and US investors may still file arbitration claims related to legacy investments within three years after the termination of NAFTA. For claims filed after the three-year period, Mexico and the US have conditioned and limited their consent to arbitration, distinguishing between claimants who have regular investments and claimants who are parties to covered government contracts.[5]

Claimants with regular investments may only challenge measures in breach of Articles 14.4 (national treatment), 14.5 (most-favored nation treatment), and 14.8 (expropriation, excluding indirect expropriation).

Moreover, and importantly, claimants must initiate domestic litigation in the courts of the host state before submitting their claim to arbitration. They can only commence arbitration if there is a final decision of a “court of last resort of the respondent or 30 months have elapsed” after the initiation of the domestic court proceedings. Another noteworthy addition is a four-year statute of limitations for investment-related claims.  This means that investors may have to be quick to bring their claim in the courts in order to make sure they have time to bring their arbitration claim following the 30 month litigation period.

Claimants who are parties to covered government contracts enjoy a broader scope and direct access to arbitration (after a six-month cooling off period). They may challenge measures in breach of the whole Chapter 14. Claims under a covered government contract will be subject to a three-year statute of limitations.

ISDS between Canada and Mexico

Absent from Chapter 14 of USMCA is any provision for Canadian investors in Mexico and Mexican investors in Canada to submit claims to arbitration. In the post-NAFTA era, these investors will necessarily have to pursue claims under the investor-state dispute settlement provisions of the CPTPP (which has also not yet entered into force). The CPTPP, also known as TPP-II, succeeds the Trans-Pacific Partnership which never entered into force after the United States withdrew its support in early 2017. The ISDS provisions under the CPTPP are narrower than those under Chapter 11 of NAFTA. They impose a higher burden of proof on investors to establish breaches of investment obligations and give governments more leeway to implement public welfare measures without giving rise to claims of expropriation.

The CPTPP was signed by 11 countries in March 2018. The agreement will enter into force 60 days after ratification by at least half of the signatories. Mexico was the first country to ratify the agreement, followed by Japan and Singapore. Canada has yet to ratify the agreement.

Entry into Force of the USMCA

The USMCA has yet to be signed but is expected to be signed later this year.  The USMCA remains subject to legal review for accuracy, clarity and consistency. The Parties still need to complete their domestic ratification procedures and other internal procedures required for ratification.  After the all Parties notify the other Parties that ratification has been accomplished, the USMCA will enter into force on the first day of the third month following the last notification.

Until such time as the USMCA enters into force, which could take months or years to accomplish, the NAFTA provisions (including the ISDS provisions) will remain in force.  It is unlikely, if not impossible, that the USMCA can be ratified in the US prior to the mid-term Congressional elections.  It should be expected, therefore, that the ratification of the USMCA will be considered by the incoming US Congress.  In any event, the timing and eventuality of the USMCA entering into force is uncertain.

The text of the USMCA can be found here [https://ustr.gov/trade-agreements/free-trade-agreements/united-states-mexico-canada-agreement/united-states-mexico].

*We thank Faye Williams, an articling student at Baker McKenzie Toronto, for her assistance with this post.

[1] See Bilateral and Regional Trade Agreements, Australian Government Productivity Commission (November 2010), p. XXXVI (Chapter 14); Report 165: Trans-Pacific Partnership Agreement, Australian Joint Standing Committee on Treaties (November 2016), Chapter 6. Venezuela denounced the ICSID Convention in 2012 and terminated a bilateral investment with the Netherlands in 2008. See, eg, Luke Eric Peterson, Venezuela Surprises The Netherlands With Termination Notice For Bit; Treaty Has Been Used By Many Investors To ‘Route’ Investments Into Venezuela, IA Reporter (16 May 2008); Netherlands to terminate BIT with Slovakia in wake of Achmea, Lacey Yong, GAR, (02 May 2018). Indeed, some other countries have terminated or denounced BITs or MITs, however, most IIAs have sunset or survival clauses which guarantee that the provisions will remain in effect from 5 to 20 years after termination. See generally Denunciation of the ICSID Convention and BITs: Impact on Investor-State Claims, UNCTAD Issues Notes No. 2, December 2010, pp. 3-4.

[2] It is also possible that one of the Parties could espouse a claim against the other on behalf of the investor.  But this has almost never occurred in the past and it does not seem likely that the Parties here will bring such claims on behalf of their investors.

[3] See supra, at n. 1.

[4] Scott Sinclair, Canada’s Track Record Under NAFTA Chapter 11 North American Investor-State Disputes to January 2018, Canadian Centre for Policy Alternatives, Jan 2018, pp. 1, 4.

[5] The USMCA defines covered government contracts as “a written agreement between a national authority of [Mexico or the US] and a covered investment or investor of [Mexico or the US], 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.”

From NAFTA to USMCA: What’s New and What’s Next?

October 3, 2018 CSIS

After over a year of negotiations and just hours before an October 1 deadline, the Trump administration and government of Canadian Prime Minister Justin Trudeau managed to reach a deal to bring Canada into a new trilateral free trade agreement with Mexico to replace the 25-year-old North American Free Trade Agreement (NAFTA). The new trilateral deal, the U.S.-Mexico-Canada Agreement (USMCA) has been hailed as a win by the leaders of each country. President Trump and his trade team claim the deal will rebalance trade with Canada and Mexico and be a boon for U.S. autoworkers and farmers. While USMCA maintains the core duty-free trade between the three countries brought about by NAFTA, it does contain additions and changes from its predecessor that are more than just cosmetic. Some of the most extreme U.S. proposals were pared back while many parts of the so-called “modernization” agenda made it into the final deal. In some areas, USMCA “will become the template for the new Trump administration playbook for future trade deals,” a Trump administration official said. The conclusion of negotiations with Canada and Mexico along with an apparent truce with Europe may allow the Trump administration to turn more of its focus to its growing trade dispute with China. Still, some questions linger about USMCA.

Q1: What are some the most significant changes in USMCA compared to NAFTA?

A1: The following areas will see the largest changes from USMCA.

Automotive rules of origin: USMCA will require that 75 percent of auto content be made in North America in order for automobiles to qualify for preferential, duty-free treatment. By comparison, NAFTA’s auto rule of origin was 62.5 percent. Of the 75 percent content threshold required by USMCA, 40-45 percent must be made by workers that earn at least $16 an hour. The wage requirement will be phased in over five years. It is essentially a U.S. or Canada content requirement as wages for Mexican autoworkers are not close to that level. The Trump administration may have traded some additional auto manufacturing jobs in the United States for higher car prices and a less globally competitive auto industry. The higher rule of origin in USMCA and wage requirement may disrupt existing supply chains designed around the NAFTA rule of origin. USMCA rules may constrain where automakers can source certain parts, which could boost manufacturing costs.

Investor-state dispute settlement: The special arbitration mechanism contained in NAFTA that allowed investors to sue NAFTA countries for discriminatory actions will be phased out between the United States and Canada, and its coverage will be significantly trimmed for investors in Mexico. The investor-state dispute settlement provision (ISDS) of USMCA will cover investments in Mexico only in oil and gas, power generation services, telecommunication services, transportation services, and the management of ownership of infrastructure. The paring back of ISDS is a major win for U.S. Trade Representative Robert Lighthizer, who views it as a means for corporations to undercut country’s sovereignty and as political risk insurance that encourages outsourcing.

Dairy and agricultural market access: The United States was able to win access to Canada’s heavily protected dairy, egg, and poultry markets while allowing Canada to export more dairy, peanuts, and sugar products to the United States. The dairy market opening achieved by the United States is one area where President Trump was able to strike a better deal than what the Obama administration managed to achieve in the Trans-Pacific Partnership (TPP) negotiations. USMCA will provide the United States access to about 3.6 percent of Canada’s dairy market while TPP only provided the United States access to 3.25 percent of the market. Canada also committed to eliminate its class 7 milk program, which had drawn the ire of the U.S. dairy industry. The complex class 7 program artificially incentivized Canadian cheese and processed food manufacturers to use domestically produced milk protein concentrate instead of foreign imports. The Canadian dairy industry has condemned USMCA for putting the industry “in jeopardy,” while theU.S. Dairy Export Council voiced lukewarm support for it. The United States was also able to resolve Canadian practices that discriminated against U.S. wine and grain.

Digital trade: USMCA contains provisions on digital trade similar to those negotiated in TPP. One significant improvement from TPP is a blanket ban on data localization requirements that does not provide an exception for financial services firms.

De Minimis: USMCA will raise the threshold at which imports from Canada and Mexico will be subject to customs duties, a priority for many in the U.S. business community. For Canada, the de minimis level will be raised from C$20 to C$40 for taxes and allow duty-free shipments of up to C$150, from C$20. Mexico will allow duty-free shipments of up to $117, from $50. The U.S. de minimis threshold is $800.

Sunset: USMCA contains a renewable 16-year term, a huge improvement for Canada and Mexico over the five-year sunset clause originally pushed by the Trump administration. The three countries will meet six years after the agreement comes into force to decide whether to renew the pact for another 16 years.

Currency: For the first time, the United States has managed to include rules regarding currency manipulation and monetary policy in the core text of a trade agreement. Requirements related to transparency in foreign exchange activity will be subject to USMCA’s state-to-state dispute settlement mechanism.

Q2: What steps do the president and Congress have to take to implement USMCA?

A2: The Trade Promotion Authority (TPA) law passed by Congress in 2015 sets out the procedures for negotiating trade agreements and bringing them into force. President Trump notified Congress on August 31 of his intent to sign a trade agreement with Mexico and potentially with Canada. That notice set off two TPA timelines, a requirement to publish the full text of the agreement within 30 days and the option to sign USMCA as early as November 29. The text of USMCA was published by the Trump administration online on October 1. Mexican Economy Secretary Ildefonso Guajardo told a Mexican news outlet that the deal could be signed by the leaders of the three parties at the G20 Leaders’ Summit in Buenos Aires at the end of November. That would allow the outgoing Mexican Pena Nieto administration to sign the deal before the incoming Andres Manuel Lopez Obrador administration takes power on December 1.

Once the agreement is signed, the president has 60 days to report to Congress on changes to U.S. law that are required to comply with the agreement. Within 105 days of the agreement being signed, the U.S. International Trade Commission (ITC) must complete a study of the agreement’s economic impact.

Additionally, Congress will have to pass legislation to implement USMCA. Congress and the Executive Branch usually cooperate in drafting the implementing legislation as well as an accompanying Statement of Administrative Action (SAA). The president must provide Congress with the final legal text of the trade agreement and a draft SAA it proposes to take to implement it 30 days before it submits its draft implementing bill to Congress. After receiving the draft implementing bill, the House Ways & Means and Senate Finance Committees may hold mock markups of it to further advise the president on what changes should be made in the final implanting legislation. Mock markups are not required by TPA. Alongside the draft implementing bill, the president must send Congress another copy of the final legal text of the agreement, the SAA, an explanation of how the implementing bill and SAA will affect U.S. law, and an explanation of how the implementing bill meets the objectives laid out by Congress in the TPA law. The president must also submit a plan for enforcing the agreement and other reports along with the draft implementing bill.

TPA also contains special, expedited procedures for Congress to consider the final implementing bill. After Congress receives the final bill from the president, it has 90 days of being in session to act on it under TPA rules. Having jurisdiction over revenue legislation, the implementing legislation is referred to the House Ways & Means and the Senate Finance Committees. The former may take up to 45 days in session to consider the bill and report it to the House floor. If the implementing legislation, which cannot be amended, is not reported out of committee within 45 session days, it is automatically discharged to the floor. Once on the floor, the House must vote on it within 15 session days. Once the House has passed it, TPA provides the Senate Finance Committee 15 session days to vote on it, at which point it is automatically discharged to the Senate floor. The full Senate then has 15 session days to consider it as well before a vote is required.

Q3: How likely is it that Congress passes legislation to implement USMCA?

A3: USMCA certainly isn’t dead on arrival on Capitol Hill. Thus far, Republican lawmakers have voiced tepid support for the agreement while some key Democrats have remained neutral and stopped short of opposing USMCA outright. President Trump on Monday conceded that he is “not at all confident” about his trade pact’s fate in Congress and added that “anything you submit to Congress is trouble.” Republicans are likely to throw their weight behind President Trump’s first signature trade win despite some aspects of the deal introducing managed trade that run counter to the traditional Republican embrace of free trade. While some Democrats could be pleased with the USMCA rules on investor-state dispute settlement, auto rules of origin, and even maybe labor, it will be a tough ask for them to support what could be a legacy item for a president that is deeply unpopular with the Democratic Party. A key question is whether the current, Republican-controlled Congress will vote on the trade deal or if consideration of USMCA will slip into the next Congress, which could well include a Democrat-controlled House of Representatives. There is some belief that the administration could jam a vote on USMCA in the current Congress by submitting the implementing legislation before the U.S. ITC completes its economic analysis of the deal. Democrats, however, have claimed that NAFTA’s replacement won’t be voted on before 2019, and that remains the most likely scenario.

Q4: What happens to the Section 232 national security tariffs on steel and aluminum from Canada and Mexico? What about potential Section 232 tariffs on automobiles?

A4: The steel and aluminum tariffs were not resolved as part of the USMCA deal, although Canada and Mexico were granted some protection from potential tariffs on autos and auto parts. Talks on the steel and aluminum tariffs are expected to begin now that USMCA has been completed. If the United States imposes Section 232 national security tariffs on autos and parts, 2.6 million passenger vehicles and $32.4 billion of auto parts from Canada will be exempt from the duties. For Mexico, 2.6 million passenger vehicles will also be exempt, as well as $108 billion worth of auto parts.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Jack Caporal is an associate fellow with the CSIS Scholl Chair in International Business.

Critical Questions are produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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