Delivered July 31, 2006 to the Standing Committee on International Trade, Ottawa
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.
Background of current situation
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:
- 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.
- 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.
- 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.
- 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.
Major clarification needed
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%.
As to carry-forward
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
As to carry-back
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.
1. Simply choosing the method of allocation of quota proved to be a difficult and frictional exercise, replete with practical and adjudicatory problems which lasted throughout the five years of that Agreement.
2. This legislative change required that antidumping and countervailing duties collected by the United States be distributed to the American companies supporting the complaint. Canada and other countries brought the matter to the WTO which finally decided that it violated the United States’ trading obligations. The United States have now promised to rescind it but not for a year or so.
3. The assessment of this Softwood Lumber Agreement is a matter for Parliament, as many legislative and regulatory changes will be necessary to put into effect the export quota scheme the Agreement foresees and the collection of export taxes which might be different from region to region of Canada. It is also a matter for each member of the Canadian softwood lumber industry, since each exporter must decide whether to forego the return of deposits it would otherwise be able to claim in entirety and since the Canadian government has required that the Agreement not come into force unless at least 95% of those entitled to refunds agree to that sacrifice.
4. When I speak here of the proposal of July 1, 2006, I speak also of the Errata issued by the two countries, also on July 1, amending the Agreement (just prior to its "initialing", apparently) to provide for a "standstill", the absence of any new antidumping or countervailing proceedings, for a year following any unilateral termination by the United States under Article XX.
5. Except the Atlantic provinces.
6. Above US $355.
7. And an "anti-surge" penalty.
8. Above US $336 but not as high as US $ 355.
9. Between US $316 and 355.
10. US $315 or less.
11. It was during the administration of George Washington that the first American special duties were imposed on softwood lumber imports.
12. The International Trade Commission only ever found in this current round that imports from Canada threatened injury to American producers, not that any injury had ever been caused, and even this finding was found to be unsubstantiated by both NAFTA and WTO panels.
13. This money is being spent by several Canadian governments, all Canadian softwood lumber industry associations, and every company which exports softwood lumber. A proper accounting of this expense ought to take account also of an enormous amount of time and effort spent by Canadian deciders following, understanding, planning, cooperating and deciding.
14. The decision of the Court of International Trade of July 23, 2006, is effectively confirmation that the Canadian side won in its NAFTA process and that the US cannot use its defeat at the WTO as a pretext to adopt determinations meant to circumvent its defeat at the hands of the NAFTA panels. The US Coalition of complainant producers has already announced it will file an appeal.
15. The current proposal would result in the return of more than 80%, leaving a billion dollars in the US, half of which would go to Canada’s producers’ competitors, notwithstanding that such a distribution could otherwise occur only under the Byrd Amendment which has been declared illegal and anyway inapplicable to Canada on a number of grounds. Notwithstanding these factors, which are galling, 80% of the deposits now, with certainty, rather than a probable 100% in two years is an acceptable compromise.
16. Whether the impetus which has pushed American agencies to such extremes has been an atmosphere charged politically or by conviction on principle is not the point here. The fact is that extremes never seen in other disputes have come in this one and now threaten to infect others.
17. We have already seen leakage into the dispute concerning Canadian wheat.
18. And the Americans defending, even to the extent of an Extraordinary Challenge to a NAFTA Committee whose judgment, when rendered, was also promptly labeled ‘moot’ by them.
19. This would mean that it would be in the US interest to raise even the most futile arguments and to appeal the judgments on every one of them, so as to prolong the dispute as much as possible and extract the greatest amount possible of non-refundable amounts nevertheless called "deposits". It would also mean that the United States is of the view that deposits which should never have been collected at all, for that is the import of the NAFTA decisions we have had, should nevertheless not be returned.
20. The refunds are in law due not to the producers but to "importers of record", though the one is often the other.
21. With a possible two-year extension, as was provided by the April 27 term sheet: Article XVIII.
22. Article VII:4,5. Canada had agreed to ask for quota to be established on a monthly basis but for compliance to be determined on a quarterly and annual basis, using quarterly quota limits, with a 10% carry-forward and carry-back from quarter to quarter. This would have been consistent with the April 27 term sheet, but is a very far cry from what we see now. It would have provided for unlimited flexibility from month 1 to month 2 and from month 2 to month 3, rather than the 12% limited and conditional flexibility we see now, and a flexibility of 10% of a quarter rather than 12% of a month from month 3 to month 4. Canadian industry’s surprise and consternation on reading the July 1 document is not difficult to understand.
23. This was the situation also with the 1986 Memorandum of Understanding between Canada and the United States.
24. Article XI:1,2 of the GATT 1994 prohibits quota restrictions on exports except in times of shortage.
25. Some argue that third-countries might complain, on the basis that the Canadian industry appears to be given a guaranteed access up to a certain percentage of the American market, or that Article IX gives to Canada a benefit in the event of certain levels of third-country penetration into the American market. This is unlikely, though, in my opinion. The third countries have no obstacle to increasing their US market share without limit (and they have indeed been increasing their market share, at Canadian expense, during the course of the US antidumping and countervailing proceedings), and the benefit which that might bring to the Canadians would only be the reimbursement of an export tax that the third-countries’ exporters do not have to pay in the first place. Third-countries would have a definite complaint, however, should antidumping or countervailing proceedings be initiated against them in the United States, since the United States has offered to Canada the alternative of this Agreement, which would not be available to those third-countries. Third-countries which import from Canada might also invoke Article XIII:1 of the GATT 1994 which requires that limitations on exports be applied on a non-discriminatory basis and not, for example, only to exports to a particular country, in this case the United States.
26. Annex 2A paragraph 4.
27. On February 8, 2006, President Bush signed into law the prospective repeal of the Byrd Amendment in the context of the Deficit Reduction Omnibus Reconciliation Act of 2005, but only for duties collected after October 1, 2007.
28. On April 7, 2006, the Court of International Trade ruled that the US government contravened US law by distributing duties collected on goods imported from Canada.
29. That is, paragraph 4 of Annex 2A to the Agreement has the very discrimination found constitutionally impermissible in the Byrd Amendment.
30. And others which are the subject of other litigation including suits brought by Canadian exporters against the United States under Chapter 11 of the NAFTA.
31. The documentation which applicants must complete to earn payment of the refunds due to them, and which must be submitted to the Canadian government which has put itself in the position of middleman for the returns, pose several difficulties. There will evidently be great difficulty, and recrimination, if parties entitled to refunds do not get them and if any part of the over 4 billion dollars the Agreement would take from the treasury in Washington and send to Ottawa ends up staying there, undistributed.
32. Except for the Atlantic provinces, every province is its own Region, and British Columbia is divided into two: Article XXI:45. The economics of lumber harvesting and milling are so different in different parts of Canada that a variable approach was necessary.
33. The list could be very long if we had the luxury of time. I also leave off this list certain other changes which I know are the objective of much of the British Columbia industry as my experience does not allow me to pronounce upon them.
34. Millions board feet.
35. No Canadian manufacturer has the capacity to do this in any event.
36. I say "at least" because even allowing repayment on a yearly basis, or even a seven-yearly basis, would leave the Region taking only as much of the American market as has now been agreed.
36. Indeed, Article XI:2 of the GATT 1994 requires that an export licence scheme not be administered in a way to alter the normal ratio between domestic production and exports.
37. The assessment of this Softwood Lumber Agreement is a matter for Parliament, as many legislative and regulatory changes will be necessary to put into effect the export quota scheme the Agreement foresees and the collection of export taxes which might be different from region to region of Canada. It is also a matter for each member of the Canadian softwood lumber industry, since each exporter must decide whether to forego the return of deposits it would otherwise be able to claim in entirety and since the Canadian government has required that the Agreement not come into force unless at least 95% of those entitled to refunds agree to that sacrifice.
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