US Expert Finds Fishhooks in China/NZ Trade Deal

While media coverage of the China-NZ Free Trade Agreement has focused almost entirely on the possible dollar gains, scant attention has been paid to the equally valid exposure of New Zealand to compensation claims – should any NZ government be so bold in future as to pass laws or regulations that a foreign investor feels will impact on profitability. Last week, I forwarded the China/NZ FTA investment rules to Professor Matthew Porterfield at Georgetown University, and he has come back with a list of the possible traps the FTA document contains.

Porterfield has written extensively on international trade law, and the trade rules about expropriation. Clearly, he begins, New Zealand’s sovereignty wouldn’t be endangered if the FTA investment rules proved no different to the compensation mechanisms currently available under domestic law to local firms. “[But} I’m under the impression that your law generally doesn’t require compensation for ‘indirect expropriation’ or what we refer to in the US as regulatory takings.’Not so under the China/NZ FTA. The way Porterfield reads the relevant Annex 13 provisions, the FTA exposes our government to greater risk of being sued than the US government faces – even though its laws on property rights are generally regarded as being the world’s most stringent.

“Even under U.S. regulatory takings law,” Porterfield says, “which is considered to be among the most protective of property rights of any country, regulatory measures must generally cause complete or near complete destruction of the value of property in order to constitute acts of indirect expropriation.

Not so, he points out, with the FTA. The wording meant to safeguard New Zealand’s position, as a I warned in Scoop last week, could well fail to withstand the full blast of international trade law. Porterfield cites an example : “Clause 3(a) of the China-NZ agreement, in contrast, suggests that regulatory measures that cause ‘severe’ deprivations of property constitute acts of indirect expropriation. Many routine regulatory decisions – such as land use planning measures – can have significant adverse effects on the value of property, which arguably could be construed as ‘severe.’”

This is not the only point where the language used in the FTA to try and insulate New Zealand against aggrieved foreign investors proves to be insufficient. Porterfield explains : “The language of clause 3(b) – indicating that measures which are ‘disproportionate to the public interest’ can constitute acts of indirect expropriation – is also problematic, given that the balancing of the relative benefits and burdens of regulatory measures is highly subjective, and is a function traditionally assigned (in democracies) to the legislative branch of government.“

This is a delicate way of saying that democracies usually retain for themselves the right to decide whether on balance, a social, economic or environmental need requires it to change the investment rules within its own territory. Governments do not normally and happily sign away their freedom to make decisions on whether such actions are ’ disproportionate to the public interest.’ Yet in the FTA, we have surrendered the power to make final rulings on such matters, and outsourced the ultimate call to an un-elected arbitration panel sitting somewhere overseas, in the likes of Geneva.

It is not as if Porterfield, or anyone else, is saying that foreign firms should not qualify for compensation if a host government changes the investment rules, mid stream. The point is whether such rules are more favourable to the foreign investor than to local firms under domestic law. That danger is real. Post NAFTA, US trade and business groups lobbied Congress very aggressively for “ no greater rights” provisions to be inserted retrospectively into NAFTA, and within any future US trade agreements.

They had only limited success. As Porterfield wrote in 2004, the changes to expropriation conditions in NAFTA and in proposals for the Free Trade Area of the Americas pact, ‘provide foreign investors with significantly greater rights’ than the Takings Clause that governs US domestic law.

The impact can be considerable. Consider say, if a future New Zealand government wanted, for climate change reasons, to limit the development of a class of economic activity, such as the coal industry. Or merely wanted to change zoning rules.

The FTA inhibits such ability. Porterfield cites zoning as an example of the risks to which that the China NZ FTA now exposes us. “Clause 4(a) indicates that regulatory measures that have a ‘discriminatory effect’ against a class of which an investor is a part can constitute acts of indirect expropriation. This language could potentially make NZ vulnerable to a wide range of claims.”

“Note,” Porterfield adds,” that the language does not indicate that the class must be based on foreign nationality. Legislation generally singles out different classes of economic actors for different treatment. Zoning regulations, for example, divide different types of land use (residential, commercial , agricultural, etc.), into different classes and subclasses and subject them to different rules, which can have significant economic impacts of the members of these different classes . This is perfectly legal – at least under the domestic law of the United States – but could
potentially be subject to challenge under the China-NZ agreement. “

There are further problems. “ Paragraph 4(b) appears to convert contractual breaches by the government of NZ into acts of indirect expropriation that could be challenged under the agreement. Typically, contract disputes are handled by domestic courts,” Porterfield says laconically, “although there is a growing trend towards adjudication of these types of claims before international tribunals, which are generally viewed as being more friendly fora for foreign investors. “

So much for Annex 13, and its attempt to enable New Zealand to enjoy the benefits of foreign investment, without risk to our sovereignty. Other aspects of the FTA strike Porterfield as posing equal, or even greater cause for concern. “You didn’t ask about it, but I’d urge you to take a look at Article 143 – ‘Fair and Equitable Treatment’ – which has been the basis for more successful claims by foreign investors against government sunder investment agreements than provisions regarding ‘indirect expropriation.’ Fair and equitable treatment has been interpreted by international tribunals to include a right to a ‘stable and predictable regulatory environment,’ which has been used to successfully challenge changes in regulatory and tax standards.” The infamous MAI treatry, for that very reason, sought to bind governments to 20 year investment rule regimes, without any right of variance.

Trade law reality has been a steep learning curve for New Zealand. During the Lockwood Smith/ Tim Groser era of trade negotiations during the 1990s, we were the free love hippies of global trade. We rarely sought protection, and virtually gave our bargaining positions away, in the apparent belief that if we voluntarily lived the free trade life ( no tariffs, maan) New Zealand would become an inspiration for all of our uptight trading rivals. It didn’t quite work out that way.

Thankfully, our attitudes have since hardened somewhat. In the wording of the China FTA, New Zealand has tried to install protections for our ability to make our own rules and to pass our own laws and regulations in future, without inviting foreign investors to launch compensation claims when we do so. Porterfield’s analysis suggests that the attempt has largely failed, and we are stuck with the investment rules regime contained within the China/NZ FTA.

Obviously, we need to learn from the experience and should not simply seek to import the China FTA investment rules wholesale into the “P4” deal now looming on the horizon. In February, Trade Minister Phil Goff welcomed the United States’ interest in joining our existing trade pact with Chile, Singapore and Brunei. Perhaps significantly, the US is interested in the extension of that deal into financial services and investment.

Goff’s enthusiasm for US involvement in the P4 deal needs to be tempered by these comments from New Zealand’s former ambassador to the US, Dr John Woods. In a lecture at Canterbury University last October, Dr Woods observed :

One perhaps surprising proposition was that the United States did not really negotiate in any generally accepted sense of the word, and as a corollary did not know how to negotiate very well at all. The U.S. came to the negotiating table in it’s role as the world’s only super-power, it understood its own status and brought with it not so much bargaining positions as truths. As one participant put it, “cultural traits impinge heavily on negotiations if the United States regards the issues as of critical importance to it. Impatience and arrogance come to the fore, with the U.S. pushing so hard that the situation can become ugly”. The United States’ underlying stance was that the other negotiating party should either accept it’s proposals, or adjust to the reality of them anyway. This elucidation clearly struck a nerve with some foreign participants.
More consistent with my own experience, it was remarked that the U.S. did indeed negotiate but at least 80 per cent of the time internally, with itself, within the American system. As the result of that domestic process, at the beginning of negotiations proper the foreign negotiating partner would be presented with the take-it or leave-it proposition: “This is the best we can get for you from our system, and you’d better believe it.” The lead U.S. negotiators were always conducting at least two simultaneous negotiations, worried about how the issues themselves would play out with the other side, and much more importantly how the negotiations would be viewed from the Hill i.e. by the U.S. Congress.”