Canada: Ontario Domestic Content Rules Facing WTO And NAFTA Challenges

Last Updated: August 15 2011

Article by Andrew Lord and James Kelsall, Summer Student

Ontario's feed-in-tariff ("FIT") program is currently facing legal challenges from two international parties upset with the domestic content requirements required by the program. Japan is challenging the domestic content requirements at the World Trade Organization ("WTO"). Texas power company Mesa Power ("Mesa") has commenced a dispute under the North American Free Trade Agreement ("NAFTA"). Both Japan and Mesa claim that the domestic content requirements unfairly disadvantage international parties wishing to participate in Ontario's renewable power market by giving preferential treatment to local providers contrary to Canada's free trade obligations under the General Agreement on tariffs and Trade, 1994 ("GATT") and NAFTA.

The FIT program

The FIT program was established to foster increased production of renewable energy in Ontario. Administered by the Ontario Power Authority ("OPA"), the program offers long-term, premium fixed-price FIT contracts for the purchase of energy from renewable energy producers. These contracts however are only available to producers who have used a prescribed percentage of materials and labour from Ontario suppliers in the construction of their facilities (e.g., solar farms must have a minimum of 60% domestic content). By introducing a FIT program that is subject to domestic content requirements, the government has both stimulated huge investment in new renewable generation projects while also creating green collar manufacturing jobs in the province to support those projects.

Many international project developers and manufacturers have responded by setting up operations in Ontario. However, not all international players see the FIT program as an opportunity. Both Japan and Mesa view it is a trade distorting public policy.

The WTO complaint by Japan

On September 13, 2010 Japan initiated its claim, asserting that the domestic content requirements of the FIT program:

  • accord less favourable treatment to imported equipment than that accorded to like products originating in Ontario, in violation of Article III.4 of GATT;
  • constitute "quantitative regulation" that favours domestic suppliers., in violation of Article III.5 of GATT;
  • appear to be trade-related investment measures that violate Article III of GATT, in violation of Article 2.1 of the Agreement on Trade-Related Investment Measures; and
  • offer financial contribution or a form of income or price support that is contingent upon the use of domestic over imported goods, in violation of Article 3.1(b) and 3.2 of the Agreement on Subsidies and Countervailing Measures

Canada has responded in defence of the program, pointing out many similar renewable energy programs operating in other WTO member countries. Japan and Canada have been in consultations since the fall of 2010. As previously reported, Japan recently escalated the dispute by requesting that a formal dispute settlement panel be struck.

On July 20, 2011, the Dispute Settlement Board ("DSB") established a panel to hear and rule on the dispute. Members of the panel should be appointed shortly, as Japan and Canada each had 20 days from July 20th to select three to five experts to examine the complaint. WTO dispute resolution panels usually take six months to hear a dispute, but may do so in three months in urgent cases. The panel then prepares a report which is issued to WTO members for consideration. Within 60 days of issuance, the report will be adopted, unless the DSB decides by consensus not to adopt the report or one of the parties notifies the DSB of its intention to appeal. Assuming the complaint is not abandoned or settled, it could take at least 5-7 months (well after the provincial election) to be resolved at the WTO.

In the event that the WTO panel finds in favour of Japan, and the decision of the panel is adopted by the WTO's Dispute Settlement Body, and Canada does not appeal the decision (or loses an appeal), Canada will be compelled to adjust its policies and/or provide some form of compensation to Japan. If it fails to do so, Japan may ask the WTO for permission to impose countervailing trade sanctions. Such sanctions should in principle be targeted at the renewable industry. However, aggrieved countries sometimes choose to target other industries (particularly those with a strong lobbying voice with the federal government).

The NAFTA complaint by Mesa Power

On July 2, 2011, Mesa Power issued a Notice of Intent to file a claim against Canada for violation of Chapter 11 of NAFTA. Chapter 11 permits private entities like Mesa to sue the state parties to NAFTA for compensation when state actions adversely affect private investments in contravention of NAFTA. Mesa is reportedly seeking C$775 million in damages in connection with the following alleged breaches of NAFTA:

  • OPA changed interconnection rules for the Bruce Region such that two Mesa projects that had been favourably ranked under the shovel-readiness criteria applied at the launch of the FIT program were displaced by projects by Canadian developers, all of which is in contravention of Canada's obligation under NAFTA Article 1105 to accord a minimum level of fair an equitable treatment to foreign investors and which also violates the national treatment and most favoured nation principles under Articles 1102 and 1103;
  • the domestic content requirements are a direct violation of NAFTA Article 1106, which prohibits requirements that investments achieve a given percentage of domestic content;
  • that allowing the OPA to act in contravention of NAFTA is itself a violation by Canada of its obligations under Article 1503(2) with respect to state enterprises.

Mesa also appears to be aggrieved by the preferential grid access granted to the Korean consortium led by Samsung under its special deal with the province. However, it is unclear that this complaint can be resolved under NAFTA, which only covers Canada, the U.S. and Mexico.

Filing a Notice of Intent is the first step in bringing a Chapter 11 claim under NAFTA. Under the dispute settlement rules, the Notice of Intent must be given at least 90 days before Mesa files its formal claim. Mesa will therefore not be in a position to file its formal claim until October 4, two days before the provincial election. It would likely take an arbitration tribunal several months thereafter to resolve the dispute.

Possible issues with the two claims

We observe that both Japan and Mesa may have legal obstacles to overcome in proving their claims. GATT contains certain exemptions for government procurement activities, which may apply to the government-created, OPA-administered FIT program (although these exemptions are modified by a separate Agreement on Government Procurement to which both Canada and Japan are parties). GATT also contains exemptions for measures intended to protect human, plant or animal life or conserve exhaustible natural resources. Canada may attempt to rely on these exemptions by emphasizing the environmental policy underlying Ontario's transition to green energy under the FIT.

NAFTA also contains exemptions for government procurement and slightly broader exemptions for measures that protect the environment or preserve natural resources. Additionally, Canada may argue that the rule changes that disadvantaged Mesa Power did not arbitrarily target foreign investments.

Jurisdictional implications

Canada's constitutional division of powers introduces an additional level of political and practical complexity in resolving trade disputes. The FIT program, its establishment and administration, falls exclusively under Provincial jurisdiction by virtue of section 92(13) of the Constitution Act (1867). By contrast, all matters relating to Trade and Commerce fall to the control of the Federal government under section 91(2). As a result, both the WTO and NAFTA claims must be brought against Canada at the federal level, but the measures that give rise to the claims are entirely within the legislative control of Ontario at the provincial level. If Canada loses or settles either claim, it will be up to Ontario to adjust its policies.

This division of powers problem is particularly relevant in the current political climate. Prime Minister Stephen Harper's federal Conservatives recently won a majority in Ottawa. Premier Dalton McGuinty's provincial Liberals are up for re-election on October 4. However, the provincial conservatives, led by Tim Hudak, have been aggressively attacking Premier McGuinty for his renewable energy policies. Prime Minister Harper has clashed with Premier McGuinty over partisan differences in the past and is supporting Tim Hudak. Ottawa may choose to acknowledge merit in the trade disputes to help support Hudak's position that the FIT program is ill conceived. However, Ottawa will have to take care not to undermine a program that is both creating jobs and consistent with the federal government's goal of positioning Canada as a clean energy superpower.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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