Canada: Requiring Foreign Investors To Spend Specific Amounts In R&D Violates NAFTA Chapter 11: Decision On Liability In Mobil v Canada

The decision in Mobil Investments Canada Inc. and Murphy Oil Corporation v Government of Canada under ICSID's Additional Facility Rules has found a petroleum board's imposition of a new requirement on foreign investors to spend millions of dollars per year in research and development (R&D) and education and training (E&T) in breach of Chapter 11 of the North American Free Trade Agreement (NAFTA).¹ Although the result of the decision on liability was leaked to the press in late May 2012, the text of the tribunal's decision has only recently been made public.

The tribunal rejected the argument that introducing compulsory investment requirements violated Mobil and Murphy's legitimate expectations by failing to provide a stable regulatory framework for their petroleum projects, but unanimously found that the impugned measures constituted prohibited performance requirements. In so doing, the tribunal provided important takeaways regarding both the concept of performance requirements and the method for interpreting whether or not a new measure falls under a host state's reservation under NAFTA.

The dispute

The dispute arose following the Canada-Newfoundland and Labrador Offshore Petroleum Board's (the Board) adoption of new guidelines in 2004 requiring investors in offshore petroleum projects to, inter alia, spend a fixed percentage of project revenues on an annual basis on R&D and E&T activities. Until then, the Board had encouraged oil companies to commit to "a series of basic principles" instead of imposing specific requirements.

When the 2004 guidelines were introduced, Mobil and Murphy had been operating the Hibernia and Terra Nova oil fields for a number of years and had already collectively invested $163.7 million in R&D in Newfoundland and Labrador to address the projects' many environmental and technological challenges. They reduced their investment by 50% in 2001 because less R&D was needed at the production stage.

Mobil and Murphy challenged the provisions of the 2004 guidelines requiring investors to spend in R&D and E&T and the enforcement of this requirement by the Board under Chapter 11 of NAFTA. The dispute was heard by three arbitrators under the Additional Facility Rules of ICSID.

NAFTA performance requirements

This is the first time a NAFTA tribunal considered whether imposing mandatory R&D and E&T investments constitute prohibited "performance requirements" under NAFTA Article 1106(1)(c), which article provides as follows:

Mobil and Murphy argued that imposing "expenditures in the Province in excess of what investors would otherwise spend" contravened the purpose of NAFTA and violated Article 1106. Canada argued that the R&D and E&T requirements did not "necessarily compel the purchase, use or accordance of a preference to local goods or services," and distinguished between prohibited sourcing/local content performance requirements, which are aimed at protecting a domestic market, and the R&D and E&T investments, which are aimed at strengthening the host state's knowledge capacity and promoting sustainable development.

The tribunal set out two questions in order to determine whether Article 1106 (1)(c) had been violated: (1) "do the R&D and E&T requirements under the 2004 Guidelines (and the application thereof) constitute 'services' within the meaning of Article 1106"; and (2)  "whether the 2004 Guidelines compel spending on R&D and E&T such that they constitute a 'requirement' to 'purchase, use, accord a preference to goods produced or services provided in its territory.'"

Tribunal: mandatory expenditures prohibited

The tribunal unanimously found that the impugned requirements were compulsory and that, "The 2004 guidelines were designed to ensure that expenditures for R&D and E&T services occur in the province, [...] implying a legal requirement for the purposes of Article 1106." In a somewhat more forced analysis, the tribunal held that, taken in context, the meaning of "services" was broad enough to encompass the investment requirements. According to the tribunal, interpreting "services" to include R&D and E&T was consistent with how the term was used elsewhere in the treaty's text as well as with NAFTA's underlying purpose to prevent the distortion of free trade and "eliminate barriers to trade and increase investment opportunities." The tribunal thus unanimously found that the requirement to annually invest a specific amount in R&D and E&T, where an investors' spending is a "central feature" and not an "ancillary objective or a consequence" of the impugned measures, constitutes a breach of NAFTA Article 1106(1)(c).

The majority of the tribunal found that the 2004 guidelines were not saved by Canada's performance requirement reservation for the crude petroleum and natural gas industries. The majority established two criteria that must be met for a new measure to fall within a reservation: (1) the specific attributes of the measure must be connected and consistent "with the attainment of the object and purpose of the reservation" and (2) the new measure must represent a continuation of the approach already taken in respect of the existing measure and subordinate measures under the reservation.

The second criterion is particularly onerous in that a new measure will not fall within a reservation if it is inconsistent with existing measures adopted under that reservation, regardless of whether the new measure is consistent with the language of the reservation itself. Unfortunately, the majority of the tribunal did not give specific guidance on how "consistency" should be established in future cases, leaving investors with some uncertainty as to whether other performance requirements might be permitted under Canada's reservation.

Having found the existence of an unjustified breach of NAFTA, the majority of the tribunal concluded that Mobil and Murphy were entitled to recover damages – a final award on quantum is anticipated.

Footnote

1 Mobil Investments Canada Inc. and Murphy Oil Corporation v Canada (ICSID), Decision on Liability and on Principles of Quantum of May 22, 2012, online: Foreign Affairs and International Trade < http://www.international.gc.ca/trade-agreements-accords-commerciaux/assets/pdfs/mobil-12.pdf> [Decision on Liability].

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