Trade Law: Non-Violation Complaints – “Legitimate Expectations” & “Good Faith”

During my 21 years at the Department of Foreign Affairs and International Trade (DFAIT) – now known as Global Affairs Canada (GAC) – I was privileged to represent Canada in a number of GATT, WTO, and NAFTA trade disputes and one somewhat obscure but important case under the Canada- U.S. Free Trade Agreement (CUSTA). While the case was not a “headliner” the Panel decision in Puerto Rico Regulations on the Import, Distribution and Sale of UHT Milk from Québec [USA-CDA-1993-1807-01] was important in demonstrating the application of a claim of “non-violation nullification or impairment” (“NVNI”). One of the few state-to-state trade panels under the CUSTA, the 1993 challenge involved Puerto Rico measures prohibiting the sale of ultra-high temperature (“UHT”) milk. Pursuant to the CUSTA and the NAFTA which superseded it, the parties to the agreement are responsible for the measures of their subnational bodies.

UHT milk is produced by treating fluid milk to a high temperature for a specified period of time. The milk is then cooled to room temperature and is aseptically packaged in hermetically sealed containers. The shelf life of UHT milk is between six and twelve months at room temperature. From 1977 t0 1991, Québec exported UHT milk throughout the Caribbean region and dominated the Puerto Rico market where it was sold on the basis of the Puerto Rico Secretary of Health’s determination that it was produced and processed under conditions and standards that were ”essentially equivalent” to those in Puerto Rico. No shipment of UHT milk from Québec was ever rejected as unsafe. However in 1991, responding to pressure from the U.S. Food and Drug Administration (“FDA”) to upgrade its milk regulatory system, the Puerto Rico Departments of Health and Agriculture joined the National Conference on Interstate Milk Shipments (”NCIMS”). It adopted the Pasteurized Milk Ordinance (”PMO”). The FDA’s milk program that was designed to enforce strict milk industry adherence to safe sanitation standards and practices. The procedures provided for a mandatory certification process.

Québec producers were told that would need to adopt regulations in accordance with the PMO otherwise the sale of its UHT milk would no longer be permitted. Québec was not a member of the NCIMS and was not in position to implement the PMO or its procedures. The Government of Canada’s position was that UHT milk from Québec qualified for entry into Puerto Rico under provisions the PMO, which authorizes the sale of milk outside ”routine official supervision” if it is processed under conditions ”substantially equivalent” to the PMO. Canadian and Québec officials sought to establish the equivalency of the Québec and Puerto Rico UHT milk regulatory systems and to establish a modus operandi for rating the Québec UHT milk in the future. The United States invited Québec to participate in the NCIMS program, but indicated that budgetary constraints made certification outside full participation in the NCIMS impossible.

The continued diplomatic exchanges centred around the provisions of the CUSTA that acknowledged the right of the parties to adopt new technical standards but that recognized the danger of governments raising new trade barriers under the guise of health or other technical standards. Negotiations failed to resolve the matter Canada took the matter to dispute settlement arguing that the new Puerto Rico licensing requirements governing the import, sale and distribution of milk constituted a traded prohibition that breached Article XI of the GATT which is incorporated into the CUSTA under Articles 407 and 710. Canada also argued that the Puerto Rico licensing requirements breach GATT Article III as incorporated into the FTA under Articles 501 and 502 as the Québec UHT milk was being treated less favourably than a like domestic products. Canada also submitted that the Puerto Rico’s treatment of Québec UHT milk breached the FTA’s in Chapter 7 of the agreement pursuant to which the parties agree to “facilitate trade in agricultural products” by working together “to improve access to each other’s markets through the elimination or reduction of import barriers.” Its position was that Chapter 7 required the parties to respect “equivalent technical regulatory requirements and procedures” where full harmonisation is not feasible.

In its final argument Canada was that even if the Puerto Rico measures were consistent with CUSTA obligations that their application nullified or impaired the benefits Canada could reasonably have expected to achieve under the agreement. (This will be referred to as an “NVNI” claim – Non-Violation of the technical standards but Nullification or Impairment of expected benefits.) We note that the option of a NVNI claim arguably makes the scope of the trade dispute settlement system based on GATT principles roader than that of other international dispute settlement mechanisms which are confined to adjudicating substantive violations of the agreement in question. Some trade law scholars have concluded that the objective of maintaining the balance of concessions and benefits meant it was important to provide a remedy when domestic regulatory arrangements may be consistent with the letter of the law but upset that balance.

The Panel ruled that the United States and Puerto Rico had the right to adopt new higher standards and rejected Canada’s Article 407 (GATT XI) import prohibitions and Articles 501 and 502 (GATT Article III) national treatment arguments. For the Panel, the key issue was the manner in which U.S. and Puerto Rico authorities responded to requests by Canada to recognize that UHT milk from Québec met the level of health standards required. Reviewing the response, the Panel reviewed the issue of product standards as addressed in Chapter 7. While acknowledging that Puerto Rico’s actions made it impossible for Québec milk to comply with its requirement and “… was far from exemplary … “ the Panel concluded that the Chapter 7 included “no hard obligations.”

The Panel then reviewed Canada’s argument the exclusion of UHT milk had nullified and impaired Canada’s reasonable expectations under the FTA. The applicable provisions of the FTA were Articles 1801:1 and 2011:

1801:1….the provisions of this Chapter shall apply with respect to the avoidance or settlement of all disputes regarding the interpretation or application of this Agreement or whenever a Party considers that an actual or proposed measure of the other Party is or would be inconsistent with the obligations of this Agreement or cause nullification or impairment in the sense of Article 2011….

2011:1 If a Party considers that the application of any measure, whether or not such a measure conflicts with the provisions of this Agreement, causes nullification or impairment of any benefit reasonably expected to accrue to that Party, directly or indirectly under the provisions of this Agreement, that Party may, with a view to satisfactory resolution of the matter, invoke the consultation provisions of Article 1804 and, if it considers it appropriate, proceed to dispute settlement pursuant to Articles 1805 and 1807….

The Panel noted that the origin of Article 2011 of the FTA was to be found in GATT Article XXIII:1 and that Article 2011 explicitly linked nullification and impairment with the reasonable expectations of the parties under the FTA . It determined that the matter that should decide consistent with then GATT practice which requires that:

  • the parties have negotiated a tariff concession,
  • one party has subsequently introduced a government measure which has upset the competitive relationship between like imported and domestic products,
  • the measure could not reasonably have been anticipated at the time of the negotiation of the tariff concession.

The Panel concluded:

In The United States asserted that Canada must have been aware that Puerto Rico would eventually adopt the PMO as part of a general move to upgrade the standard of milk production in its territory. With respect to the adoption of the PMO itself, the Panel is in full agreement with the United States’ position. The issue, however, relates not so much to the adoption of the PMO itself, as to the manner of its application and interpretation in Puerto Rico with respect to UHT milk from Québec. In this regard the Panel considers that Canada’s reasonable expectations under the FTA were indeed upset and to this extent, Canada has suffered nullification and impairment of the benefits which it could reasonably expect. These expectations flow from both the history of the product and from the FTA.

The Panel noted that Québec UHT milk was consumed around the world and that it had been consumed in Puerto Rico for 14 years, the UHT process was regulated by measures which mirror the U.S. Low-Acid Canned Food Regulations. It the FTA was a wide-ranging free trade agreement that specifically provided for the definition of “equivalence” of agricultural product standards.

In these circumstances, the Panel believes that Canada did have a reasonable expectation that an equivalency study would be undertaken, and that, in the midst of a difficult negotiation concerned with reaching an acceptable method of determining the equivalence of Québec’s UHT milk production standards to those of the PMO, the authorities of Puerto Rico would not unilaterally close their market to UHT milk from Québec before the issue had been resolved between the Parties on the basis of the FTA.

On this basis, the Panel ruled in favour of Canada and recommended an expeditious and conclusive equivalency study be conducted without delay and if the Canadian standards were found to have the same effect as the PMO, UHT milk from Québec should then be re-admitted for sale and in Puerto Rico. For Canada, the NVNI argument proved to be the “trump card” and the Panel found that the Puerto Rico measure defeated Canada’s “reasonable expectations” of benefits it could derive from the CUSTA. Behind this decision to plead NVNI was the then General Agreement on Tariffs and Trade (GATT) jurisprudence. As the eminent trade law expert, Professor John H. Jackson noted and his seminal work, World Trade and the Law of GATT,  “… the prerequisite to invoking (the dispute settlement process under GATT) Article XXIII does not depend upon a breach of the GATT agreement and furthermore, does not depend upon any measure of another contracting party.” Rather, the key element is the concept of “nullification or impairment.”

GATT

The basis of NVNI is found in GATT 1994 Article XXIII:1(b)

Article XXIII: Nullification or Impairment

  1.  If any contracting party should consider that any benefit accruing to it directly or indirectly under this Agreement is being nullified or impaired or that the attainment of any objective of the Agreement is being impeded as the result of

 (a) the failure of another contracting party to carry out its obligations under this Agreement, or

 (b) the application by another contracting party of any measure, whether or not it conflicts with the provisions of this Agreement, or

 (c) the existence of any other situation.

the contracting party may, with a view to the satisfactory adjustment of the matter, make written representations or proposals to the other contracting party or parties which it considers to be concerned. Any contracting party thus approached shall give sympathetic consideration to the representations or proposals made to it.

While almost all GATT (and WTO) disputes have been decided on examination of whether measures violated a substantive obligations, there have been a few non-violation cases that help illustrate how the concept has been applied in practice. The first adopted GATT Panel to consider a NVNI claim was the 1950 Working Party Report, The Australian Subsidy on Ammonium Sulphate [II/188]. Chile based its claim on a tariff concession from Australia on exports of its sodium nitrate fertilizer. At the time of the negotiations, Australia had subsidies in place for the purchase of both imported sodium nitrate fertilizer and the domestically produced competing ammonium sulphate fertilizer. When Australia discontinued the imported product this led to a shift to the purchases of the now cheaper domestic product. While the Working Party found that while Australia was under no GATT obligation to continue to subsidize the Chilean product, the change in treatment constituted nullification or impairment as “… the action of the Australian Government which resulted in upsetting the competitive relationship…could not reasonably have been anticipated by the Chilean Government … at the time it negotiated the duty-free binding on sodium nitrate.” In Germany – Treatment of Imports of Sardines [1/S 58], a GATT Panel examined the issue of Norway’s reliance upon a 1951 tariff concession from Germany on its exports of sprats and herring and Germany’s subsequent action that granting better tariff treatment to exports of a competing species of sardine from Portugal. The GATT Panel rejected Norway’s argument that the species of fish were “‘like products.” While the MFN obligation of GATT Article I did not therefore apply, the Panel found that the change in tariff treatment “could not reasonably have been anticipated by the Norwegian Government at the time it negotiated for tariff concessions,” and ruled in favour of Norway on non-violation grounds. The Panel noted that the species in question were closely related and that had been treated equally by Germany for tariff purposes since 1925.

The 1985 the Panel, EEC – Tariff Treatment on Citrus Products [L/5776] considered a complaint by the United State about European Economic Community (EEC) tariff preferences on citrus products from certain Mediterranean basin countries. While a number of the tariffs in question were not bound the Panel found that benefits that the United States could reasonably have expected in connection with negotiations had been impaired. This ruling was considered as being somewhat controversial and raised the concerns about the growth of NVNI claims as the Panel opened the door to NVNI findings in the absence of a negotiated tariff concession. The 1992 Panel – EEC – Payments and Subsidies to Processors and Producers of Oilseeds [37/S, 86], considered a U.S. complaint regarding 1962 tariff concessions from the EEC on oilseeds and its subsequently introduced subsidy programs designed to insulate oilseed producers from competitive harm due to import price fluctuations. The Panel ruled in favour of the U.S. NVNI claim, finding that, “… the United States may be assumed not to have anticipated the introduction of subsidies which protect Community producers of oilseeds completely from the movement of prices for imports and thereby prevent tariff concessions from having any impact on the competitive relationship between domestic and imported oilseeds.”

WTO

The Uruguay Round negotiations provided an opportunity to review the principle of NVNI and with the creation of the World Trade Organization (WTO) came new the rules on dispute settlement. Article 26 of the new WTO Dispute Settlement Understanding (DSU) maintained the non-violation option, requiring a “detailed justification” for such claims. Pursuant to Article 26(1) (b) when a measure that does not violate WTO treaty commitments but nevertheless nullifies or impairs benefits, there is no obligation is to withdraw the measure. Rather, a “mutually satisfactory adjustment” is required to compensate the aggrieved party. Article 26(1) (c) provides for arbitration over the level of nullification or impairment suffered which would serve as a benchmark for the permissible level of any retaliation.

To date, three WTO Panels have addressed NVNI claim on the merits. In Japan – Measures Affecting Consumer Photographic Film and Paper [ WT/DS44, adopted 22 April 1998], the United States challenged a wide range of various Japanese rules regarding foreign investment arguing that they had the collective effect of preventing U.S. manufacturers of photographic film from competing successfully in the Japanese market. The Panel found that that the United States failed to meet its burden of proving that the measures at issue were causally responsible for the inability of U.S. exporters to penetrate the Japanese market. The Panel pointed to the limited role of NVNI cases in GATT history.

This suggests that both the GATT contracting parties and WTO Members have approached this remedy with caution and, indeed, have treated it as an exceptional instrument of dispute settlement. We note in this regard that both the European Communities and the United States in the EEC — Oilseeds case, and the two parties in this case, have confirmed that the non-violation nullification or impairment remedy should be approached with caution and treated as an exceptional concept. The reason for this caution is straightforward. Members negotiate the rules that they agree to follow and only exceptionally would expect to be challenged for actions not in contravention of those rules.

The Panel determined that a NVNI claimant had to demonstrate – (i) the application of a measure; (ii) a benefit owing to the complainant under some WTO agreement; and (iii) that the measure has nullified or impaired that benefit. The Panel stressed the importance of the issue of the competitive balance.

[I]t must be demonstrated that the competitive position of the imported products subject to and benefitting from a relevant market access (tariff) concession is being upset by (‘nullified or impaired…as the result of’) the application of a measure not reasonably anticipated. The equation of ‘nullification or impairment’ with ‘upsetting the competitive relationship’ established between domestic and imported products as a result of tariff concessions has been consistently used by GATT panels examining non-violation complaints. For example, the EEC — Oilseeds panel, in describing its findings, stated that it had ‘found…that the subsidies concerned had impaired the tariff concession because they upset the competitive relationship between domestic and imported oilseeds, not because of any effect on trade flows’..

In European Communities – Measures Affecting Asbestos and Asbestos-Containing Products

[WT/DS135], Canada challenged 1996 French health-related ban on the sale and importation of asbestos and asbestos-containing goods. Canada’s argued that its exports of chrysotile asbestos fibres for use in construction were safe with proper precautions. Canada relied on tariff concessions on asbestos and asbestos-containing products dating back to 1947. The Panel determined that Canada had failed to meet its burden of proof with respect to its legitimate expectations as medical evidence regarding the carcinogenic properties of asbestos was extensive by that time of the Uruguay negotiations and Canada should have foreseen future acts to ban asbestos products. Both the Panel and the Appellate Body rejected the EU arguments and ruled that even if measure is permissible under the GATT Article XX (b) exception for protection of human health it can still be the subject of a successful non-violation claim.

By creating the right to invoke exceptions in certain circumstances, Members have recognized a priori the possibility that the benefits they derive from certain concessions may eventually be nullified or impaired at some future time for reasons recognized as being of overriding importance. This situation is different from that in which a Member takes a measure of a commercial or economic nature such as, for example, a subsidy or a decision organizing a sector of its economy, from which it expects a purely economic benefit. In this latter case, the measure remains within the field of international trade. Moreover, the nature and importance of certain measures falling under Article XX can also justify their being taken at any time, which militates in favour of a stricter treatment of actions brought against them on the basis of Article XXIII:1(b).

In Korea – Government Procurement. Korea – Measures Affecting Government Procurement [WT/DS163, adopted 19 June 2000] the United States challenged Korean government procurement restrictions on the participation of foreign suppliers on the construction of a new airport nullified or impaired benefits under the WTO Government Procurement Agreement (GPA). The procurement activities governed by the GPA are identified by the government agency doing the procurement. Once an entity is listed as “covered” Article XXII of the GPA provides for the potential application of nullification or impairment in the proper circumstances. The United States complained that it had been misled during the GPA negotiations as to the scope of Korea’s commitments. The Panel accepted such a claim was possible in principle but ruled that the United States had constructive knowledge of Korean legislation that placed the project in question under the jurisdiction of a non-covered entity. In an important passage the Panel took a new perspective on NVNI with a reference to the “good faith” obligation under customary international law.

In our view, the non-violation remedy as it has developed in GATT/WTO jurisprudence should not be viewed in isolation from general principles of customary international law. As noted above, the basic premise is that Members should not take actions, even those consistent with the letter of the treaty, which might serve to undermine the reasonable expectations of negotiating partners. This has traditionally arisen in the context of actions which might serve to undermine the reasonable expectations of negotiating partners. This has traditionally arisen in the context of actions which might undermine the value of negotiated tariff concessions. In our view, this is a further development of the principle of pacta sunt servanda…The principle of pacta sunt servanda is expressed in Article 26 of the Vienna Convention in the following manner: “Every treaty in force is binding upon the parties to it and must be performed by them in good faith”…

Also, the Panel did clarify that a non-violation complaint does not require evidence of improper behavior:

[W]e do not mean to introduce here a new requirement that a complainant affirmatively prove actual bad faith on the part of another Member. It is fairly clear from the history of disputes prior to the conclusion of the Uruguay Round that such a requirement was never established and there is no evidence in the current treaty text that such a requirement was newly imposed. Rather, the affirmative proof should be that measures have been taken that frustrate the object and purpose of the treaty and the reasonably expected benefits that flow therefrom.

As with the CUSTA Panel, each of these GATT/WTO cases there is an underlying concept of fairness at play. In some ways this might be compared to the concept of equity in common law jurisdictions which can be traced to back to medieval England. Equity was born out of the need to introduce balance to the rigid procedures of England’s courts and the common law system based on principles of law shaped and developed in preceding cases. Faced with intricate procedures and “letter of the law ‘technicalities, subjects turned to the king for relief. These requests for relief to a royal court (Chancery) were a pleas for equity – just and fair treatment – based on the king’s mercy or conscience. Principles of equitable relief have grown into a body of law that complements the common law, and in the same way NVNI focuses on concepts of reasonable, overall balance and the underlying need for fairness.

Comments

  1. An interesting comment that shows why one ventures into international trade disputes at one’s peril. They are *very* complicated!

    They are sufficiently complicated that it is hard to tell just what the results are when the disputes are described. I can’t figure out what happened with the Quebec/PR dispute: was there a remedy for the nullification finding? Did the US back off, or was the PR market reopened?

    In the EU-Canada dispute about asbestos, did Canada ‘win’, since (as noted here) the Panel and Appeal body both rejected the EU’s arguments? (Is the description right, by the way, when it says that the Panel held that Canada should have expected such actions … but then the Panel rejected the EU’s arguments? If so, it’s even more confusing…)

    Opponents of the investor-state dispute provisions of the TPP (and other free trade agreements) say that the US has never lost a claim – presumably meaning against it, not claims brought by it or its investors that did not succeed. So they argue that Canada’s public interest regulations are at risk, or even if they can be maintained, we will have to pay off US and other foreign investors for maintaining them, and may have little hope of reciprocal benefit for our investors (violating their public policy …)

    Was the Quebec/PR a win or a loss for the US?

  2. John – I appreciate the interest and your questions. Here are my responses:

    Q. …sufficiently complicated that it is hard to tell just what the results are when the disputes are described. I can’t figure out what happened with the Quebec/PR dispute: was there a remedy for the nullification finding? Did the US back off, or was the PR market reopened?

    A. Yes, there was a remedy and the Panel ruled that the United States had the obligation to ensure that PR brought its practiced into conformity with the FTA by conducting an expeditious and conclusive equivalency study be conducted without delay. This is what Canada and Québec were seeking in the first place. As I recall the PR authorities did end up re-opening market as it was clear that Canadian standards were equivalent.

    Q. In the EU-Canada dispute about asbestos, did Canada ‘win’, since (as noted here) the Panel and Appeal body both rejected the EU’s arguments? (Is the description right, by the way, when it says that the Panel held that Canada should have expected such actions … but then the Panel rejected the EU’s arguments? If so, it’s even more confusing…)

    A. Canada`s NVNI claim was not successful and I apologize as I should have set this out in a clearer fashion. The helpful obiter from the Panel vis-a- vis EU position that would put further constraints on applicability of NVNI claims were of interest in broader contest. A little like Lord Denning dissents if you like …

    Q. Opponents of the investor-state dispute provisions of the TPP (and other free trade agreements) say that the US has never lost a claim – presumably meaning against it, not claims brought by it or its investors that did not succeed. So they argue that Canada’s public interest regulations are at risk, or even if they can be maintained, we will have to pay off US and other foreign investors for maintaining them, and may have little hope of reciprocal benefit for our investors (violating their public policy …)

    A. The United States has yet to lose a NAFTA Chapter 11 Investor-State Dispute. But take a look at recent comments in press regarding the recently launched claims by Trans Canada. In any event, the investor-state dispute settlement issue is a separate debate. These claims are not the same things as state-to-state cases under GATT, WTO, NAFTA and other agreements. There have been many involving the Unites States as claimant and respondent and the USA has lost quite a few. For example, see the Beer II case in the early 1990’s – https://www.wto.org/english/tratop_e/dispu_e/91alcohm.pdf. Numerous U.S. federal and state measures were found to be inconsistent with GATT rules – a big loss for the Amercans!

    Q. Was the Quebec/PR a win or a loss for the US?

    A. Win for Canada/Québec and a loss for USA/PR.

  3. Thanks for taking the time to address my questions, Michael. Useful to remember the distinction between the state-to-state DR process and the much more controversial investor-state process. I have been called on to work on trade law matters for the province on occasion, so it’s useful to keep the details clear.

    Though I remember a very experienced consultant that we had engaged at the time of the CANUSTA saying that in trade law matters, it’s not about who’s right or wrong, but about who’s big or small. The US is usually the bigger party where Canada is concerned. (I know that’s a reason that we have traditionally liked multilateral agreements, so we have others to balance the US – not sure that worked so well with the TPP, though.)

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