The Proposed Softwood Lumber Agreement of July 1, 2006 - Comments by Simon V. Potter

These comments are my own. They are not necessarily the views of my client, the Quebec Forest Industry Council, or of any of its members, or of my firm, McCarthy Tétrault.

They are informed by nearly 30 years of practice in international trade law, and by several years of involvement in the softwood lumber dispute. I have been intimately involved in that dispute from the beginning of the last Softwood Lumber Agreement, which put an end to Lumber III. It was an export quota scheme which lasted for five years from April 1, 1996, to March 31, 2001. I was then involved in its very difficult and thorny application¹ through to its expiry, into the antidumping and countervailing proceedings (Lumber IV) instituted by the United States the next business day, through all the determinations of the Department of Commerce and the International Trade Commission, through all the NAFTA and WTO challenges, through all the attempts at settlement, through the challenges to the United States’ Byrd Amendment², through the proceedings before the Court of International Trade in New York and through all the discussions about what this has meant for the Canadian economy, for the Canada-US trading relationship and for the credibility of our two most important trade treaties.

I hope then to offer some perspective from which to judge the proposal of July 1, 2006, for a new Softwood Lumber Agreement³, a hybrid which would impose on Canadian exporting Regions⁵, according to their preference, either an Option A export tax regime with (except during periods of very high prices⁶) a varying level of export tax⁷ or an Option B regime of export quota plus tax, but at lower rates. The quotas would, in principle, limit the Region to its share of a Canadian share of 34% of the United States market if prices are not very high⁸, or 32% if prices are low⁹, or 30% if prices are even lower¹⁰.

This has certainly been the longest running trade dispute in world history¹¹, and the one with the greatest economic consequence.

It is true that we in Canada speak of the more than 5 billion US dollars in duty deposits paid on exports over the past several years, and that is a great deal of money, but those have been price-increasing assessments on only one third of the softwood lumber sold in the United States. Presumably, the other two-thirds have also felt a price effect. That is, American producers, even though the International Trade Commission found that Canadian sales had never injured them¹², have now earned in profit several billion dollars in prices which American consumers would otherwise not have paid.

This not only gives an idea of the importance of the dispute in dollar terms, but also indicates why the Canadian lumber industry fears that, without a settlement, we will soon be facing Lumber V. The prospect of several billion dollars of extra profit for the Coalition members will surely generate Lumber V.

Even if a settlement were not necessary to avoid falling into another round of litigation and another several years of contested duty deposits, a reasonable settlement is justified in order to stop the astonishing expense of defending Lumber IV. Canadian dollars in the tens of millions a year are being spent in this defence¹³; these dollars have in my opinion been very well spent, as the results are nearly uniformly in Canada’s favour¹⁴, but it would be nice not to have to spend this money for a while.

A reasonable settlement is also justified if it guarantees the early return of nearly¹⁵ all the deposits still being held in Washington, rather than spending more litigation money to get, probably but not entirely certainly, a refund later, with the exchange rate trend making that refund worth less then than what it would be worth now.

Besides these monetary costs of non-settlement, there are the unquantifiable but no less important costs on Canada’s trading relationship with the United States. Though nearly all trade occurs with very little difficulty, this dispute has monopolized commentary and cross-border discussion for some time, and has led to high emotions and accusations. In short, it has done precisely the opposite of what Chapter 19 of the NAFTA was meant to achieve, a growing confidence among business people that the rule of law will be followed and treatment will be fair.

As a trade lawyer, I must add to this disturbing list the unhappy precedents we have seen arise from the charged¹⁶ atmosphere surrounding this dispute. What would have been unacceptable before or in other disputes has been acceptable here, and is now a threat in other trade litigation.¹⁷ We have seen American agencies act with what appears to be contempt of the NAFTA-panel judicial review decisions, as though deference due by the panels to the agencies means that no respect is due by those agencies to the panels. We have seen the ITC simply repeat, based on the same record, a threat-of-injury determination which the WTO had said that no objective or impartial body could reach. We have seen American authorities seek to use that WTO defeat as a pretext in order to issue a new determination and make "moot" the determination we had spent so long contesting¹⁸ before the NAFTA panels. We have seen the United States declare that, even if Canada won every NAFTA case, the deposits would never be returned but that, contrary to past practice and every expectation at the signing of the NAFTA, the decisions once final would be honoured only prospectively.¹⁹

It has long been clear that, if a reasonable settlement can be found, these costs must be avoided, and both markets given a chance to return to some normalcy, and trading relations also given a chance to allow sensible rule-of-law approaches to return to the fore.

The question then becomes, is the settlement now before us just such a reasonable settlement?

My opinion, in short, is that the settlement is not good but that it can be good enough, if certain clarifications are obtained on particular points.

The proposed settlement document of July 1, 2006, followed an earlier, shorter document of about two and a half pages, a "term sheet" dated April 27, 2006. Several industry associations, including the one I represent, indicated almost immediately that they would support a settlement along the lines of that "term sheet".

Those same associations now say that the July 1 document is acceptable only if certain changes are made. It is not they who have changed their minds but the deal which has been changed beneath their feet.

They approved a settlement, even at the cost of their members’ foregoing a billion dollars, because they saw that as an investment in seven years of peace, and possibly nine. Prime Minister Harper, in the House, announced the deal similarly, as one which would provide for seven years’ peace, and that it was therefore in the interest of the Canadian producers²⁰ to agree to accept 80 cents on their dollar.

The document of July 1 calls itself a seven-year agreement²¹ but also contains Article XX, nowhere foreseen in the April 27 term sheet, which provides that either the United States or Canada can simply put an end to the Agreement, without cause or explanation, without the need for any support from any arbitration panel, on one month’s notice after 23 months. The industry did not bargain for paying a billion dollars in order to gain 23 months of security. The proposed Agreement makes no provision for the reimbursement of any part of the billion dollars in the event of early termination.

The Option B quota scheme is also not what was foreseen on April 27. The July 1 document would have all quota administered on a monthly basis²² (though with a limited carry-forward or carry-back of quota, which might allow a month’s quota to be swollen to 112% of its normal amount). The 34% share of the US market which the ITC found had never been injurious was an annual share, not a monthly share. It might have been reasonable to expect annual or, at most frequent, trimestrial operation of the quota; indeed, Canadian officials charged with the operation of the eventual quota had reassured the industry that monthly operation could never be accepted because it would be impossible to administer. Now, the July 1 Agreement would impose just that monthly rigidity, multiplying by 12 the chances of underutilization of quota and exposing civil servants and companies alike to an extremely difficult job of monthly administration of quota.

The limited carry-forward and carry-back provisions, meant to allow limited flexibility in moving quota from one month to another, do not offer the assurance needed that quota will not be lost from month to month. The Agreement does allow taking under-usage of quota in one month and adding it to the following month, up to 12% of that month, but it is not clear that the Agreement will be interpreted to allow under-usage beyond that 12% ever to be available again. This is a considerable problem in a business which does not have steady or predictable volumes month to month and in which legitimate client demands arise and die away very quickly. It is also an encouragement to what neither the Coalition nor the Canadian industry want, producing and getting product southwards across the border even in months of limited demand in the United States.

There is much else to trouble business deciders.

"Standstill", which would protect against early re-institution of antidumping and countervailing proceedings, which would not investigate free-market business but transactions artificially affected by the Agreement, applies under the Agreement only if the Agreement is terminated by the United States under Article XX, not if it is terminated by Canada or by either party under a number of other provisions, and not at the Agreement’s natural expiry. The very purpose of the Agreement is to affect volumes and prices, so it is clear that Lumber V when it comes will be unfair from its inception if it is allowed to rely in its arithmetic on those artificially affected volumes and prices.

The Agreement’s anti-circumvention clause, Article XVII, is drafted so broadly that it would expose virtually any change in provincial forestry management policy to the accusation that it constitutes circumvention of the agreement, even if it is not aimed at softwood lumber at all but, for example, pulpwood. This will freeze provincial governments’ willingness to proceed to modernizing changes which are sorely needed. Worse, it puts those governments in the practical position of having to ask American permission before going forward with policy changes.²³

These difficulties should be listed along with those the industry associations were prepared to swallow on April 27, but did not like.

The Agreement would be the antithesis of free trade. It is managed trade. It is a voluntary export restraint which is nearly certainly WTO-illegal²⁴, though presumably the United States will not be complaining to the WTO about it.²⁵

The Agreement will give US$500,000,000 to the competitors of Canadian industry.²⁶ This is so even though the Byrd Amendment which first foresaw such distributions is WTO-illegal and the US has finally agreed to withdraw it with effect in a little more than a year from now.²⁷ This is so even though American courts have now found that the Byrd Amendment is in law inapplicable to Canada or Mexico.²⁸ It is so even though the Byrd Agreement has been found to be unconstitutional in the United States, on grounds of discrimination which apply here also, in that the distribution will only go to members of the US Coalition.²⁹ This $500,000,000 will serve to make the US competitors more competitive on price, or more competitive through modernization or more able to finance Lumber V.

The Agreement contains clear unfairnesses. Remanufacturers will pay export taxes calculated, for some, on their inputs and, for others, on their finished product, depending on their shareholdings.

The Agreement would impose years of administrative difficulty and expense, and the exposure of all Canadian softwood exporters to audits and verifications, at the hands of the CBSA, the CRA and IT Canada, of their monthly operations and payments of export tax. Rather than concentrating on doing business, our Canadian businesses will be spending time and money dealing with constraints on that business.

As a trade lawyer, I should add that final determination of some of the issues raised by the aggressive stance of the Coalition and of the American administration will not come if there is an Agreement putting an end to litigation. The CIT decision of July 23, to the effect that the US cannot use defeats at the hands of the WTO as excuses to make new determinations in order to circumvent NAFTA decisions, will be under appeal without judgment being rendered on that appeal. The Coalition’s proceedings alleging unconstitutionality of the US legislation implementing the dispute settlement provisions of Chapter 19 of the NAFTA will not have been decided. These issues³⁰ could presumably be raised again in Lumber V or in another trade dispute. The Americans’ allegations, to an Extraordinary Challenge Committee, impugning the objectivity and integrity of the NAFTA panelists who heard the judicial review of the DOC’s determination of subsidization, will not receive the official dismissal they deserve. Canada will also have foregone any chance of NAFTA Article 1905 or Chapter 20 proceedings to challenge as a violation of the NAFTA the concerted attempts over the past several years to avoid NAFTA panel determinations in this dispute.

Still and all, the need for some kind of certainty after years of uncertainty, the need to obtain early return of at least 80% of the deposits³¹, the availability of a solution which is not necessarily the same for every region in Canada³², the prospect of an end to expensive and friction-elevating litigation all make it a sensible decision to settle if some of the problems I have mentioned can be dealt with.

The principal³³ difficulties which ought to be addressed have solutions which I suggest are these:

1. It ought to be clarified how Option B’s quota regime will actually work and that administration of the quota will not be such as to leave quota futilely unused. If that can be done, I am sure that many enterprises will overcome what today is considerable skepticism about the value of this Agreement. In any event, certainty of operation is needed if only from an administrative point of view. I deal with this point in greater detail below.
2. It ought to be made clear that the power given by Article XX to the United States and Canada to bring about, unilaterally and without cause or outside approval, the early termination of the Agreement will not be used unless it becomes clear that the Agreement is simply not working as expected and cannot, despite consultations, be made to work. Such an assurance would go a long way toward reassuring those who were ready to spend a billion dollars to buy seven years of peace but, correspondingly, horrified to learn that it might not be 84 months but only 24.
3. It ought to be made clear that the standstill, the delay before any new antidumping or countervailing proceedings, will apply not just in the event of early termination under Article XX. Canadian businesses will understandably be less inclined to approve of the Agreement and of their own sacrifice of a billion dollars if they believe not only that Lumber V will come early, not only that it will be financed by their own money but also that it will produce high dumping margins calculated on the basis of artificially affected transactions.
4. It ought to be made clear that changes to forestry management policies will not be considered circumvention of the Agreement if they bring forestry management closer to an open market, for example by relaxing the restrictive rules concerning use of logs in Quebec, or if they are meant to establish different pricing for pulpwood than for softwood sawlumber.

The most important of these is, to my mind, the need for certainty and fairness in the operation of the quota scheme under Option B.

Option B and its description in Annex 5 of the Agreement are sufficiently vague in their current form that they could allow for serious loss of quota through inflexibility, leaving the Option B Regions with even less market share than what the ITC has already decided was never injurious to the American producers.

That non-injurious market share was 34% on a yearly basis. Option B allows a market share higher than that only during months of extremely high prices and caps it at that even in times of prices only slightly less high. As prices dip, the cap tightens, all the way down to 30%, more than a 10% reduction below what the ITC found to be a non-injurious share. And, as the cap tightens, a growing export tax has to be paid, even though the ITC held the 34% share non-injurious without there being a duty or export tax of any kind in place.

The fear now is that Canadian exporters subject to Option B will end up being able to export even less than that tightening cap. Unless interpreted so as to avoid this result or, if such an interpretation is too difficult for some, unless Option B is amended outright, the constraint on exports will prove to be even greater than what the United States has asked for and what the Canadian government has agreed to impose.

It is at this stage probably too late to do anything to revert to a quarterly or annual administration of quota, even though monthly quota obviously increases the chances of Option B Regions having even less practically usable quota than what the Agreement’s constraints contemplate. I propose then to advance here a solution which does not require abandoning monthly administration but concentrates on the flexibility the Agreement already has in mind by its offering of a carry-forward and a carry-back which might swell a month’s quota by 12%.

If quota unused in one month must be used or lost in the month following, or if not all the unused portion can be carried forward, this will also obviously tend to produce orphan quota, or to encourage production and export shipments just when neither the Canadian industry nor the American industry wants it.

Paragraph 4 of Annex 5 contains one example of the operation of carry-forward: A Region does not use 60 MMBF³⁴ in June and applies that 60 MMBF to increase the monthly quota volume for the next quota month, say July, as long as that increase does not bring July’s quota to more than 112% of what paragraph 2 would normally calculate for July.

Another example of carry-forward, perfectly appropriate, would be this: A region does not use 60 MMBF in June and applies that 60 MMBF to increase the monthly quota volumes for the next three quota months (July, August and September) by 10, 20 and 30 MMBF respectively, as long as none of those increases brings any month above the 112% of limit.

Still another example would be underutilization of 80 MMBF in June, carried forward 60 to July, up to July’s 112% outer limit, with the remaining 20 carried forward to August. If we were to see the single example of paragraph 4 as the only way in which carry-forward can be used, then 20 MMBF would be lost for ever, never to be used, even though it could obviously be used without bringing the Region in excess of its agreed share of the American market.

That is, we should make clear that all volumes unused in a month can be used as carry-forward over at least the next three quota months and not in only one. It is worth noting that Annex 5 does not limit what can come out of, for example June, to be carried forward to July; the 112% cap applies only to what can go into July, or August. My proposal respects this protection against a shipper using up its entire quota all at once.³⁵

If all carry-back volumes must be repaid in the very next month, that next month may be seriously and unduly hampered. It may be a month of heavy demand in the United States.

Paragraph 3 of Annex 5 contains one example of the operation of "carry-back": A Region borrows 60 MMBF, 12 percent of the monthly quota volume for June, taking quota volume from the next month in which quota applies, July, and repays the 60 MMBF by reducing the monthly quota volume for July by 60 MMBF.

Another example of the operation of the carry-back would be just as appropriate: In June, a region borrows 60 MMBF and repays the 60 MMBF by reducing the monthly quota volumes for the next three quota months by 40 MMBF, 5 MMBF and 15 MMBF respectively.

That is, all carry-back volumes could be paid back within the next three quota months. This would bring a needed measure of flexibility to planning, and would avoid encouraging Canadian exporters to produce and ship during months of feeble demand. It would nevertheless leave the American markets served by Canadians, over time, only up to the level of the capped market share. Nothing in the Agreement or in Annex 5 necessarily precludes this, unless one reads the single example as the only carry-back mechanism possible.

Clarification is needed that the single example is not exhaustive, and that the Canadian authorities will apply at least³⁶ a three-month flexibility in repayment of carry-back.

There should be no impediment to the clarifications I propose.

As to Option B, we should remember that the Agreement says nothing at all about quota on a company-by-company basis but only on a Regional basis. The United States could only see any violation of the Agreement if the Region as a whole exceeded the agreed quota amounts. In any event, the flexibility I propose dilutes nothing in the limits that the Agreement seeks to impose, but only seeks to ensure that the limits are not in practice even more draconian than what the parties had in mind.

Besides being arguably bound by the guiding principle of quota allocation that it must be efficient, and must result in quota which is actually used, both Canada and the United States have a WTO obligation to make sure that export quota agreements are administered in a way to facilitate full usage of that quota, and not in a way to arrive at under-usage of that quota. Article XIII of the GATT 1944 imposes this obligation on both countries³⁷ and there ought to be no difficulty in the Canadian authorities reassuring the Canadian industry that their administration of Option B quota will incorporate the flexibility which I propose.

The clarifications as to duration, termination, standstill and circumvention can also all be given without the Agreement being affected in substance, but with its acceptability in principle and especially for business deciders being considerably enhanced.

Without these clarifications, however, many will prefer to go on winning in the litigation.

I hope that these comments will prove helpful to the Committee.

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