Metalclad Corp. v. United Mexican States, ICSID Case No. ARB(AF)/97/1

(Originally published in 2011 in International Investment Law and Sustainable Development: Key cases from 2000–2010; republished on this website on October 18, 2018. Read more here.)

Award and judicial review decisions available at https://www.italaw.com/cases/671

Keywords

Environmental measures, expropriation, fair and equitable treatment/minimum international standards of treatment, judicial review, legitimate expectations, “sole effects” test

Key dates

Notice of Arbitration: 2 January 1997

Constitution of Tribunal: 19 May 1997

Award: 30 August 2000

Decision by British Columbia Supreme Court: 2 May 2001

Arbitrators

Prof. Sir Elihu Lauterpacht, QC, CBE (president)

Mr. Benjamin Civiletti (claimant appointee)

Mr. Jose Luis Siqueiros (respondent appointee)

Forum and applicable procedural rules

International Centre for Settlement of Investment Disputes (ICSID)

ICSID Additional Facility Rules

Applicable treaty

North American Free Trade Agreement (NAFTA), Chapter Eleven, Investment

Alleged treaty violations

• Expropriation
• Fair and equitable treatment/minimum international standards of treatment

Other legal issues raised

• Challenges to awards—judicial review

1.0 Case Summary

1.1 Factual background

Metalclad involved two separate government “measures.” The first was a set of events that cumulatively denied the company a permit to operate a hazardous waste disposal facility in the village of La Pedrera, municipality of Guadalcazar, in the Mexican state of San Luis Potosi. The second was a state-level act that essentially converted the property into an ecological reserve, taking all private use rights away from Metalclad.

In 1990, the Mexican federal government issued a permit for a hazardous waste transfer station to be built by a Mexican company, COTERIN, in La Pedrera. In January 1993, the permit was extended to build and operate a hazardous waste landfill.

In April 1993, Metalclad entered into a purchase option for COTERIN, subject to the approvals to build the landfill being fully issued. In May 1993, the state government issued a land use permit for the landfill, which did not constitute an operating or building permit. In June 1993, Metalclad met with the governor of the state and believed it had obtained his support for the landfill. On 10 September 1993, Metalclad exercised its purchase option of COTERIN, on the basis of the apparent support for the project by federal and state level officials.

Shortly after Metalclad purchased COTERIN, Metalclad asserted that the state governor started a campaign against the landfill. Nevertheless, in May 1994, Metalclad again believed it had the support of the state government, and began construction. In October 1994, municipal officials ordered a halt to construction due to the absence of a construction permit. In November 1994, the company resumed construction while applying for the permit. Federal officials were alleged to have said it would be issued as a matter of course, and that in any event Metalclad had all the permits needed to proceed.

A further federal permit was issued for the final elements of the facility in January 1995. In February 1995, an environmental impact assessment was completed, approving the facility subject to some mitigation measures. This was confirmed by the federal environmental agency in March 1995. Construction was completed in March 1995, but the facility never became operational. A demonstration took place on its intended inaugural day, which allegedly blocked entry to the site with the assistance of state officials and police officers.

In November 1995, Metalclad reached an agreement with the federal officials for the operation of the facility, including additional environmental steps to be taken by Metalclad. The state government did not participate in the process and denounced the agreement after it was reached.

In December 1995, the municipality rejected Metalclad’s application for the construction permit, noting that it had denied a similar permit to COTERIN prior to its purchase by Metalclad in both 1991 and 1992. Metalclad was not notified of the meeting at which the decision not to give the permit was made.

In January 1996, the municipality initiated a legal action in Mexico’s constitutional court to challenge the federal agreement with Metalclad that purported to allow Metalclad to operate the facility. While this challenge was ongoing, the federal officials issued a permit authorizing the expansion of Metalclad’s landfill operations from 36,000 tons per year to 360,000, a ten-fold increase. The state and municipal officials, however, continued to oppose the facility and, in January 1997, Metalclad initiated the arbitration proceedings.

The above series of events was taken together to constitute the first ground of complaint of Metalclad. The second measure is far simpler: In September 1997, the state governor issued an Ecological Decree declaring the property a Natural Area for the protection of rare cacti. The decree, which created what can be understood as the equivalent of a national or state level nature reserve or park in most jurisdictions, had the effect of precluding any use by Metalclad of its facility.

1.2 Summary of legal issues and decisions

Metalclad’s claims focused on three violations of NAFTA: (1) that the series of acts leading to the denial of the construction permit and inability to operate the hazardous waste landfill constituted a breach of NAFTA’s Article 1105 on minimum international standards of treatment, (2) that the same acts also amounted to an indirect expropriation under Article 1110 of NAFTA, and (3) that the Ecological Decree in itself also constituted a breach of Article 1110 of NAFTA.

The Tribunal found in favour of Metalclad on each of these three claims and awarded Metalclad damages of US$16.5 million, essentially the amount of its sunken costs in the investment; however, Mexico sought judicial review of the decision in the court of British Columbia, Canada, where the arbitration was legally seated. On judicial review, the first two findings concerning the events leading up to the rejection of the municipal permit were annulled, but the third finding on expropriation in relation to the Ecological Decree was maintained.

2.0 Select Legal Issues

2.1 Minimum Standard of Treatment: Applying Wide-Ranging Requirements on Host States

The Tribunal equated NAFTA’s Article 1105, entitled “Minimum Standard of Treatment,” with the more broadly known language of fair and equitable treatment (FET); however, it made two broad findings that appear to have gone beyond known expressions of the FET standard as understood at that time. First, it stated that FET encompasses the obligations on government transparency that are found in Article 102 of NAFTA. It held that this combination requires the host state to ensure …that all relevant legal requirements for the purpose of initiating, completing and successfully operating investments made, or intended to be made, under the Agreement should be capable of being readily known…. There should be no room for doubt or uncertainty on such matters. Once the authorities of the central government of any Party… become aware of any scope for misunderstanding or confusion in this connection, it is their duty to ensure that the correct position is promptly determined and clearly stated so that investors can proceed with all the appropriate expedition in the confident belief that they are acting in accordance with all relevant laws. (para. 76)

The Tribunal held that the absence of any clear rule on the need or process for obtaining a construction permit in the municipality constituted a breach of Article 1105. While other tribunals have noted that neither NAFTA nor other treaties guarantee the success of an investment, the Metalclad decision places a heavy burden on governments to ensure legal certainty relating to the investment for all levels of government within a jurisdiction, including those over which they have no authority.

The second, related critical element of the FET ruling was the Tribunal’s finding that Metalclad was legally entitled to rely upon the representations of the government officials relating to all aspects of the investment, including the need for other permits and the likelihood they would be issued. This echoes the Tribunal’s point on transparency, but also goes beyond it to create a legal obligation on states flowing from the statements of government officials, even when such statements relate to matters within the jurisdiction of another level of government over which they have no legal sway.

The Tribunal added, “Mexico failed to ensure a transparent and predictable framework for Metalclad’s business planning and investment”[1](para. 99). This notion has become more developed in subsequent cases, into a broader doctrine of protecting the reasonable expectations of the investor in relying upon government representations relating to the investment. (This doctrine finds one of its widest expressions in Tecmed v. Mexico and one of its narrowest in Glamis v. United States.)

The Tribunal also ruled, importantly, that Mexico’s domestic environmental law placed all matters related to hazardous waste into federal jurisdiction, leaving little to no space for the municipal permit to be required. To the extent there may be a residual local jurisdiction, the Tribunal ruled it had not been exercised for any reason related to the actual construction, but instead was exercised in response to social and environmental concerns related to the site’s intended use as a hazardous waste landfill. The finding that followed—that there was no legal basis for not issuing the permit or that it was not in any event needed—led to the finding that Mexico also acted contrary to its domestic law and that this also amounted to a breach of Article 1105.

The Tribunal’s decision sparked a fear that the FET standard could be used to read in elements of other international treaties, such as the World Trade Organization (WTO) Agreements, as a basis for a complaint by an investor. To address and prevent this, the NAFTA Parties adopted an interpretative statement in relation to Article 1105, stating that it referred only to customary international law and thus did not include international treaties as a basis for a claim. The statement, however, did not define the scope of or tests for what was included in customary international law.

2.2   Expropriation: Applying a test that focuses on the economic impacts of the measures and the protection of the investors’ expectations

Denial of the construction permit

In relation to the series of events leading to the denial of the construction permit by the municipality, the Tribunal held that the denial of fair and equitable treatment in breach of Article 1105 also amounted to a breach of Article 1110 on expropriation. In particular, the denial of the construction permit, “notwithstanding the fact the project was fully approved and endorsed by the federal government,” was held to be an act “tantamount to expropriation” under the language of NAFTA, one that denied Metalclad the right it would otherwise have had under the federal permits to operate the landfill (para 104). That the acts of the municipality were seen as outside Mexican law further led to the view that it had effectively and unlawfully prevented the operation of the landfill, in a manner that amounted to an expropriation. This reasoning was subsequently annulled by the judicial review.

The most critical issue in the Metalclad decision was the key test used to establish whether an expropriation had taken place. At paragraph 103, the Tribunal states:

Thus, expropriation under NAFTA includes not only open, deliberate and acknowledged takings of property, such as outright seizure or formal or obligatory transfer of title in favour of the host State, but also covert or incidental interference with the use of property which has the effect of depriving the owner, in whole or in significant part, of the use or reasonably-to-be-expected economic benefit of property even if not necessarily to the obvious benefit of the host State.

This economic impact test provides a very stark test for an expropriation that would capture virtually every type of government measure. For example, most environmental protection measures, at least in the short term, impose some costs or limit some economic benefit of a business. This test therefore raised immediate concerns as to the applicable international law standard on expropriation.

The Tribunal added that Metalclad’s “justified reliance” on the federal government’s representations about the required permits, taken with the other government acts, also supported the finding of expropriation. This notion of reliance on governmental representation as a basis for a finding of expropriation comes back several times in later cases.

The Ecological Decree

The Tribunal ruled that a separate ground for an expropriation under Article 1110 lay in the Ecological Decree. It added a critical note here to its economic impact test for an expropriation as it relates to regulatory measures, stating, “The tribunal need not decide or consider the motivation or intent or the adoption of the Ecological Decree” (para. 111).

Taken with the singular economic impact test as the principle test for an expropriation, this combination would significantly limit, if not completely eliminate, the use of the traditional notion in international law of “police powers” of the state as a basis for legitimate regulation of all investors. This places Metalclad in direct conflict with later cases, most notably the Methanex v. United States decision, on this point. The different approaches adopted by tribunals with respect to expropriation have contributed greatly to the uncertainty in the field of international investment law.

Unfortunately, this could have been avoided if the purpose and nature of the measure had been considered, as it was in Methanex: this was, in fact, an indirect taking by regulation of all use of the property in order to effectively convert it to part of the public patrimony as an ecological reserve area to protect rare cacti found in the area. This is not illegal or inappropriate in itself; however, such measures, or similar measures to, for example, take land for a school or hospital, require compensation to be paid for the lost rights to use the property. This is the normal process, even when land is taken to be used for environmental purposes. This type of measure differs significantly in form and purpose from a measure designed, for example, to limit water and air pollutant emissions. Under the Metalclad approach, it would appear these types of distinctions are not relevant, putting governments into an impossible situation in terms of making new regulations. This has been the source of primary concern with the Metalclad decision.

2.3 Judicial review: National courts’ limited authority to address problems with arbitral awards

On judicial review at the Supreme Court of British Columbia, Canada, the Court held that the Tribunal acted outside its jurisdiction in reading other parts of NAFTA—i.e., NAFTA’s provisions on transparency in Article 102— into the obligations under Chapter 11. Thus, the Canadian Court annulled all of the elements relating to transparency, and because this infected a significant part of the reasoning on Chapter 11, the Canadian Court likewise annulled the Tribunal’s finding of a breach of Article 1105, as well as its finding that the breach of Article 1105 amounted to a breach of Article 1110.

The Court upheld the award, however, as it relates to the finding on expropriation as a result of the Ecological Decree. The Court stated, “The Tribunal gave an extremely broad definition of ‘expropriation’ for the purposes of Article 1110” (para. 99) based on the use of the economic impact test. The Court added that this approach was sufficiently broad to include a legitimate rezoning of property by a government. The Court found, however, that since this broad interpretation was not “patently unreasonable”—the standard a court was to apply on judicial review of an arbitral tribunal’s legal findings under Canadian law—there was no basis on review to overturn this part of the award.

Notes

[1] The Tribunal continued: “The totality of these circumstances demonstrates a lack of orderly process and timely disposition in relation to an investor or a Party acting in the expectation that it would be treated fairly and justly in accordance with the NAFTA” (para. 99). Interestingly, the Tribunal referred to a treaty that was not even in effect at the time the investment by Metalclad in purchasing COTERIN took place in early September 1993—over three months before NAFTA came into effect and two months prior to the political approval of NAFTA by the U.S. Senate. Thus, it could not reasonably be assumed that the investment was made in any expectation of NAFTA’s protections.