Canada: What Is Your Strategy For A Possible NAFTA Termination?

Last Updated: January 16 2018
Article by Heather Innes

Will President Trump terminate NAFTA?  Unfortunately, we don't know.  Some days, press reports suggest a growing possibility that he will take steps to terminate the agreement.  Other days, President Trump's pronouncements hint that he may be prepared to further negotiations. This leaves organizations in a difficult position.  If President Trump does issue a notification of intent to terminate NAFTA, the notification will trigger a 6 months termination period after which the benefits of NAFTA will no longer be available to Canadian organizations and their suppliers who rely on NAFTA duty free movement of goods across the Canadian, Mexican and US borders.  This could have a significant financial and competitive impact on your organization.

The 1988 Canada-U.S. Free Trade Agreement (the "Canada-U.S. FTA")was superseded, but not repealed, by NAFTA in 1994. If NAFTA is terminated, the Canada-U.S. FTA may be revived by default and thereby, be available to Canadian organizations for imports/exports as between Canada and the U.S.  However, it is far from a certain that the U.S. will retain and not formally terminate that agreement as well.

So, how should organizations prepare to respond to the increasingly possible (some may say likely) termination of NAFTA in the coming months.  Below is a non-exhaustive list of things you should consider when developing your organizational strategy to respond to a possible NAFTA termination:

  1. Plan for Uncertainty:   As noted, we don't know if NAFTA will survive.  Further, it remains unclear whether President Trump has the U.S. constitutional authority to terminate without the approval of the US. Congress.  We also don't know if the 1988 Canada-US Free Trade Agreement will be revived and available for Canadian and U.S. organizations.   For many organizations, NAFTA provides far reaching financial and competitive benefits for their North American business operations.  While in-house counsel can assess and help their organization navigate the termination process, provide guidance on and monitor the timing and triggers, your organization will need to develop a strategy that manages the uncertainty and can be implemented in a timely manner.  If a termination notice issues, your organization will need to respond to a short, 6-month termination timeline.  Your organization should consider taking certain steps now to ensure that you are ready to make required changes quickly (e.g. finding and validating alternative suppliers or finding ways to manage a higher tariff rate);
  2. Assess the NAFTA benefits you and your suppliers enjoy today: Your organization and your suppliers may rely on NAFTA to eliminate the tariffs on manufacturing materials and components and finished goods.  The concessions available to expedite the movement of certain classes of individuals (e.g. lawyers, engineers, etc.) across NAFTA borders also may be an important NAFTA benefit used by your organization and suppliers. Preparing a detailed inventory of the products, services and classes of individuals affected within your organization and that of key suppliers, is an important first step;
  3. Identify the impact of a NAFTA termination and alternative trading arrangements:  There are several different scenarios to consider:
  • If President Trump announces his intent to terminate NAFTA:  Although NAFTA provides that the agreement will terminate 6 months following the provision of notice, the following scenarios could arise and could affect the timing of its actual termination:
    1. A constitutional challenge may be brought before the U.S. courts to determine whether or not the President has the authority to terminate the agreement without Congressional approval; and/or
    2. i Canada, Mexico and the U.S. could agree to postpone the termination date.  For example, if the U.S. felt that the NAFTA negotiations gain positive momentum or in the face of upcoming mid-term elections, President Trump faces internal pressure from Congressional representatives whose constituents need NAFTA to export their products (e.g. farmers selling their crops to Mexico);
  • The Canada-U.S. FTA is revived (the U.S. does not terminate): If the Canada-U.S. FTA is available to provide duty elimination for certain materials, components, finished goods to the extent that they meet the applicable rule of origin content/tariff class shift requirements for U.S. and Canadian content and have the required certificates of origin, adjustment will be required.  The rules of origin under the Canada-U.S. FTA are not the same as those under NAFTA and Mexican content will not be eligible as it was under NAFTA.  Consequently, you should re-visit the Canada-U.S. FTA rules of origin to ensure that your products, materials, etc. meet the rules of origin under that agreement and you have the required supporting documents;
  • Both NAFTA and the Canada-U.S. FTA are terminated by President Trump: Canadian organizations trading with the U.S. must utilize other agreements or find alternative trading partners and customers:
    • NAFTA would continue as a free trade agreement between Canada and Mexico:  Termination by the U.S. would not change the technical status of the NAFTA relationship between Canada and Mexico.  This is a three party agreement and the exit of the U.S. leaves Canada and Mexico as parties to the NAFTA.   Goods moving between Canada and Mexico would continue to enjoy duty free treatment as long as they continue to qualify and as long as neither party withdraws from the agreement.  Note that the rules of origin likely will be affected: originating content requirements are likely to change to include only Canadian and Mexican content;
    • Ongoing trade with the U.S. at WTO MFN rates and likely without NAFTA immigration benefits:  Ongoing trade would occur at the World Trade Organization's (WTO) most favoured nation rates.  This means that the duty rate applied to goods moving into the U.S. from Canada or into Canada from the U.S. would be the same as the duties applied to similar goods flowing from other WTO countries that don't have free trade agreements into those countries. You also need to consider if and how the elimination of NAFTA could affect the movement of key personnel and service providers that support your organization in Canada and the U.S.  Without a NAFTA trade relationship between Canada and the U.S. query the impact on the overall political relationship.  If the U.S. withdrawal from NAFTA escalates trade frictions, could this impact the overall movement of goods and people across the Canada-U.S. border (e.g. slowing movement of goods and people at the border or imposing regulatory impediments)? Your organization should weigh and plan for this possible outcome;
    • Other free trade agreements are available to reduce tariffs:  Canada has a number of free trade agreements that may provide alternative sourcing and market options, including the Canada-EU Comprehensive Economic and Trade Agreement (CETA) and the Canada-Korea Free Trade Agreement. Your organization should consider whether your production/service inputs could be more cost effectively imported from other countries with which Canada has a free trade agreement. Often re-sourcing options require significant lead time for contract transition and validation, so timing is important.  New market opportunities also may be available in countries with which new FTA's have been negotiated (e.g. the EU) and may permit you to deliver finished goods to potential customers at a lower (duty free) cost.

The uncertainty surrounding the status of NAFTA negatively impacts both the equity markets and the Canadian and Mexican currencies.  It also causes uncertainty within your organization and could hamper the execution of global and domestic strategies.  Having a well thought out strategy to respond to this uncertainty, one that will position your organization to quickly adjust to a post NAFTA trading, environment, if needed, will drive confidence internally and with external stakeholders.  To react quickly you need to develop and possibly execute your strategy now, even if only partially by identifying/validating and establishing the footprint for required changes. If President Trump issues a NAFTA termination notice, you may have as little as 6 months to prepare.

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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