China: New Foreign Investment Protection Agreement With China

WHAT'S THE FUSS ABOUT?

The foes of free trade are at it again! The Council of Canadians and others on the political left are decrying the very idea that Canada and the People's Republic of China would enter into a foreign investment protection agreement (FIPA). The same opponents predicted that Canada would sacrifice its sovereignty by entering into the Canada-US FTA and after that, the North American FTA.

When Canada, the United States and Mexico incorporated the standard terms of a bilateral investment treaty in the NAFTA, three large neighboring economies agreed for the first time to provide basic investment protection to each others' investors and to allow them to submit claims for damages for breach of that obligation to an independent arbitral tribunal. Eighteen years later, the NAFTA parties have between them defended 33 investor-state claims. Although Canada has experienced a few bumps – most recently when Newfoundland expropriated Abitibi-Bowater's power generating assets – its experience has been generally positive.

Canada assumed the risk that our biggest and most frequent foreign investors would initiate investor-state claims when the NAFTA entered into force. Contrary to the naysayers' predictions, the sky did not fall. It is disingenuous for critics now to contend that Canada's new FIPA with China will expose Canadians to new or unreasonable risks.

WHAT HAS CANADA WANTED FROM CHINA?

Canada has been seeking a FIPA with China since 1994. The on-again, off-again negotiations were reputedly frustrated by China's intransigence on the important question of dispute settlement procedure.

Of central concern to Canada has been the ineffectiveness of the Chinese legal system to protect foreign investors from unwarranted interference by the state and politically connected Chinese partners. Lack of an independent judiciary, in particular, was a problem.

China was only willing to allow arbitration of disputes in very limited circumstances. It was prepared to permit arbitration to decide how much an investor should be paid if its investment was expropriated, but not whether there had been a breach of a treaty amounting to an expropriation. This was not satisfactory to Canada, because actual expropriations of foreign investments are relatively rare. More frequently regulatory or administrative action (or inaction) amounts to an indirect expropriation or other treaty breach entitling the investor to damages. A FIPA with China that lacked an effective mechanism to impartially adjudicate investors' claims would be of little practical benefit to Canada.

WHY DID CHINA FINALLY COME TO THE TABLE?

Investment treaties traditionally have been sought by capital exporting states anxious to protect investment by their nationals in developing countries, and by developing countries seeking to attract foreign investment. The rapid growth of China's economy and rise in its demand for natural resources have made it into a capital exporting state that needs to protect its own investors. According to Canadian government figures, Canadian direct investment in China was valued at nearly $4.5 billion by the end of 2011, whereas Chinese investment in Canada had reached $10.9 billion. Thus, the shoe is now on the other foot, at least in part.

WHAT DID CANADA GET IN THE DEAL?

The Canada-China FIPA provides the same treaty protections that appear in the NAFTA and Canada's post-NAFTA trade and investment treaties, with some nuanced but important differences:

• Most Favoured Nation Treatment – Canadian investors are entitled to treatment no less favourable than China accords to investors of third states, in like circumstances, in connection with "the establishment, expansion, management, conduct, operation and sale or other disposition of investments in its territory". This is equivalent to the commitment in the NAFTA.
• National Treatment – Canadian investors are entitled to treatment no less favourable than China accords to its own investors, in like circumstances, in connection with "the expansion, management, conduct, operation and sale or other disposition of investments in its territory". Note the omission of "establishment". This is less rigorous than its equivalent in the NAFTA (more on this below).
• Minimum Standard of Treatment – Each party is required to accord "fair and equitable treatment and full protection and security, in accordance with international law" to the covered investments of investors of the other party. Properly interpreted, this provides basic protection against serious arbitrariness, unfairness, lack of due process and discrimination. However, as under the NAFTA, it only applies to an investment after it has been established.
• Expropriation – The parties are prohibited from expropriating or nationalizing the investments of each other's investors – and from taking "measures equivalent to expropriation" – except on payment of compensation based on the fair market value of the investment immediately before the expropriation occurred. Although more narrowly worded, when read with the explanatory notes, this provides Canadians with effectively the same level of protection as under the NAFTA.
• Transfers – Each party is required to allow the prompt repatriation of capital and earnings of the other's investors in a freely convertible currency at a market based exchange rate, subject to limited exceptions that apply only in the event of a currency crisis. However, these exceptions are broader than those in the NAFTA, likely at China's insistence.
• Performance Requirements – The parties have agreed to abide by their commitments in the World Trade Organization Agreement on Trade Related Investment Measures. The prohibitions on measures which require particular levels of local procurement by an investor, and which tie the value of imports an investor can purchase to the level of products it exports, one similar to, but not as rigorous as, the equivalents in the NAFTA.
• Investor-State Arbitration – A Canadian investor that has suffered damages as a result of a breach by China (or a Chinese governmental entity) of any of the obligations described above may submit a claim for damages to arbitration under (for now) the ICSID Convention Additional Facility Arbitration Rules or the UNCITRAL Arbitration Rules. As in the NAFTA and Canada's other FTAs and FIPAs, there is a notice requirement followed by a cooling-off period, in this case four months. However, unlike the vast majority of Canada's other treaties, there is also a requirement for the intended claimant to resort to administrative review for at least four months before submitting a claim (see below).

There are two important nuanced differences from the NAFTA that may affect Canadian investors in China.

LIMITED PRE-ESTABLISHMENT RIGHTS

The omission of the word "establishment" from the national treatment provision discussed above denies Canadian investors in China – and Chinese investors in Canada – the same rights to establish investments in particular businesses and industries accorded to domestic investors. The NAFTA does give the parties national treatment for the establishment of investments, subject to various exceptions and reservations. The NAFTA negotiations also included commitments by the parties to liberalize foreign investment in certain sectors and industries. Under the new FIPA with China, Canadian investors will have to rely on China's movement to a more open economy, that began with its accession to the WTO in 2001 and continues with the progressive relaxation and simplification of its foreign investment laws.

However, the inclusion of "establishment" in the most favoured nation provision of the Canada-China FIPA means that Canadian investors will be entitled to whatever rights of establishment in China are accorded to their American, European and Asian counterparts. If the United States obtains special rights of establishment for its investors in its upcoming bilateral investment treaty negotiations with China, those rights should be granted to Canadian investors as well.

The main potential impediment to Chinese investment in Canada is the review provision of the Investment Canada Act, which Canada has reserved the right to apply. This entitles the federal government to review proposed acquisitions of Canadian companies by foreign investors exceeding (currently) $330 million to determine whether they will result in a "net benefit to Canada". Presently under consideration are the proposed $15.1-billion takeover of Calgary-based Nexen Inc. by a state-owned Chinese energy company, and the proposed $6 billion takeover of Progress Energy Resources by PETRONAS, Malaysia's state-owned oil company.

MORE CUMBERSOME DISPUTE SETTLEMENT FOR CANADIAN INVESTORS

Generally, any investor planning to initiate a treaty-based claim must carefully consider whether to first invoke any available domestic legal remedies. Canada's treaties typically allow an investor to seek a judicial declaration that does not involve the payment of damages at the same time as arbitrating under the treaty. An investor must carefully weigh the potential benefits and pitfalls of continuing litigation in the courts or administrative tribunals of the host state.

But the Canada-China FIPA requires Canadian investors to seek administrative review under the Law of the People' s Republic of China on Administrative Reconsideration for four months (if available). If a satisfactory solution has not been reached within four months (or if no remedy is available), the investor may submit a claim to arbitration under the FIPA. However, a FIPA claim may only be submitted if the investor discontinues court proceedings relating to the dispute (other than the administrative reconsideration proceedings) before judgment is granted.

While this may seem to present nothing more than a four month delay that will run at the same time as the four month cooling-off period, it will also add a level of complexity and uncertainty to any case where there has been a problem with the issuance of permits or other administrative action that the investor considers to amount to a breach of the treaty. China's aim, it appears, is to divert as many cases as possible to its domestic courts and tribunals, in the hope that the outcomes will either resolve the problems or ameliorate the elements of unfairness that might form the bases of treaty claims. Depending on the circumstances of a given case, a Canadian investor may find itself in a quandary about whether to pursue domestic remedies at the risk of prejudicing an eventual treaty claim.

CONCLUDING REMARKS

If not a "great leap forward", Canada's new FIPA with China certainly represents a substantial improvement in the level of protection and security for Canadians that establish investments in China. Whether the United States is able to secure better terms in its negotiations with China (which Canada will be able to take advantage of) remains to be seen. Meanwhile, Chinese investors in Canada will enjoy a level of protection similar to those accorded to American and Mexican investors under the NAFTA, and soon to be accorded to members of the European Union as well. There is no real reason to fear that the sky will fall as a result of Canada entering into this long-awaited treaty. It will enter into force as soon as it is ratified by the governments of both parties.

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