San Francisco Daily Journal
July, 1999
By Dennis Pfaff, Staff Writer

A Canadian company wants nearly $1 billion in compensation for Gov. Davis' order phasing out the controversial gasoline additive MTBE, a demand that raises critical questions about whether California's attempts to protect its environment will be dragged into the swamp of international trade law. It also may signal the development of an increasingly sophisticated approach to the use of treaties such as the North American Free Trade Agreement, subjecting environmental regulation to an arena with its own rules, lingo and players. Public access is limited, routes of appeal are murky and there are no old familiar faces.

"It's the first time in my 20 years in the law that I've ever talked to that office," said Susan Durbin, a deputy state attorney general, referring to the Office of the United States Trade Representative, which is playing a central role in the current dispute.

In fact, one of the large unanswered questions is whether California even has a voice in the debate, or who would officially represent the state. Although it was California's governor who ordered the MTBE ban, the $970 million demand last month by Methanex Corp., of Vancouver, British Columbia, is actually against the federal government, brought under NAFTA. Theoretically, the whole issue could be decided with no input from California at all.

Both state and federal officials say there will be plenty of cooperation, but at the moment nothing formal has been worked out.

"We're going to wait until we see the actual claim before we get too hot and bothered," said Durbin.

Technically, what Methanex has filed is only a notice of the company's intent to submit a formal claim at a later date. But the June 15 document filed with the State Department, and the accompanying public statements from the company, leave little doubt that the corporation is serious about pursuing what it feels it is owed under the 1994 trade agreement binding Canada, Mexico and the United States.

"The California governor's order to ban the use of MTBE in that state unfairly targets MTBE in what are really broader gasoline and water resource issues," said Methanex President Pierre Choquette in a statement issued at the time of the filing. "Our mandate is to act in the best interests of our shareholders and we are confident we have a valid claim for damages under the NAFTA."

Methanex's claim was filed under the relatively obscure Article 1110 of NAFTA's Chapter 11, which prohibits the "expropriation" of a company's assets by another country without compensation. The company produces methanol, a primary component of MTBE (methyl tertiary butyl ether), which as a result of federal clean air mandates has been widely added to gasoline in California since 1996 to help the fuel burn more cleanly.

Davis in March ordered a phaseout of MTBE, with the goal that gasoline sold in the state be completely free of the chemical by 2002. Among a class of substances known as oxygenates, the foul-smelling and -tasting MTBE has fallen increasingly out of favor as it has turned up in drinking-water wells and lakes in California. Efforts to control pollution from the chemical have included a controversial ban on certain types of popular marine engines, such as those used to power many "personal watercraft" on Lake Tahoe.

Although Durbin said "expropriation" has in the past commonly referred to a government physically seizing a company's property - for example, when a country nationalizes foreign-owned businesses - Methanex's petition resembles more of a regulatory "takings" claim.

In fact, Methanex itself used that term. The company, which also owns a subsidiary in Texas and a production facility in Louisiana, said in its June filing that approximately 40 percent of its U.S. sales are to companies that use its methanol to manufacture MTBE and that Davis' actions will end that aspect of the company's business in California.

"This constitutes a substantial interference and taking of Methanex U.S. business and Methanex's investment in Methanex U.S.," the company's filing said. "These measures are both directly and indirectly tantamount to an expropriation."

Company spokesman Michael MacDonald said the $970 million figure is based on an estimate of the "future impact of the ban on our business in California." It is also approximately the amount that the company's stock market capitalization declined around the time of the ban, MacDonald said.

"Our stockholders have already suffered those damages," he said. Instead, the company proposed a five-step alternative to a ban, including giving refiners more flexibility in the amount of clean-burning oxygenates they use and increased funding for MTBE cleanups.

"MTBE is being unfairly targeted," said MacDonald. Banning the substance "does nothing to clean up leaking underground storage tanks" or releases from marine engines.

The company's position caused Durbin to label Methanex's demand a "wisdom claim," as in questioning the wisdom of a government action. Methanex's claim "shows you how desperate some people are to keep this stuff in the stream of commerce," said Los Angeles attorney Joseph Gonzalez. The Masry & Vititoe lawyer is representing San Francisco's Communities for a Better Environment in a lawsuit against the oil industry for using MTBE in gasoline.

MacDonald objected to any characterization that the company's intent is to overturn the California ban.

"We're not seeking to change the governor's mind in California," he said. "There is no linkage between NAFTA and California regulations." There is, however, a provision in the NAFTA implementing legislation that appears to give the federal government the power to try to overturn state actions that run afoul of the trade agreement.

"No state law, or the application thereof, may be declared invalid as to any person or circumstance on the ground that the provision or application is inconsistent with [NAFTA], except in an action brought by the United States for the purpose of declaring such law or application invalid," states the clause, 19 USC section 3312(b)(2).

It is by no means certain the federal government would take such a drastic action, or even use it as leverage to try to force California to rescind the ban. Even veteran NAFTA observers say they are unclear whether that could happen.

"I don't know, if the federal government is found responsible for this amount of money, [if] there is a way to force the state of California to pay or change its policy," said J. Martin Wagner, an attorney for the Earthjustice Legal Defense Fund in San Francisco and director of the organization's international program.

Wagner, who recently authored a Golden Gate University Law Review article on the relationship among international investment, expropriation and environmental protection, said the greater danger is that governments will be dissuaded from enacting laws to protect the environment and human health in the future.

"It's like an extortion racket, in a sense," he said. Under NAFTA procedures, spelled out by officials of the U.S. trade representative's office, at least 90 days must pass after the initial filing before an actual arbitration could begin. That is triggered by the filing of a formal "notice of claim," which is followed by a second 90-day period in which a three-member arbitration panel would be picked by the two sides. That panel, with one member chosen by each side and the third by mutual agreement, would then set a schedule for the rest of the case. If the two sides can't agree on the third member, that person would be selected by the secretary general of the International Center for the Settlement of Investment Disputes, which is part of the World Bank.

The panel's authority is limited to awarding monetary damages. Technically, there is no appeal of the decision and there is also no provision for public involvement in the process, a primary sticking point for NAFTA critics.

"The truth is, the state has no seat at the table," said Daniel Seligman, director of the Sierra Club's Responsible Trade Campaign and an outspoken NAFTA detractor. "You'll have to depend on the [U.S. trade representative] to represent your interests at a trade tribunal in Paris. It's completely devoid of the due process guarantees we all know and love."

An official of the trade representative's office, who spoke on condition of anonymity, however, said any award from the tribunal would have to be enforced by an American court. That judge, presumably of a federal district court, would review the award for compliance with a number of criteria, including due process.

Those court enforcement procedures are spelled out under another international agreement, the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards. That jawbreaking name is generally shorthanded to the New York Convention, for the city where it was initially signed in 1958.

Despite fears California will be left in the cold, the trade representative official said the federal government would work to involve the state, acting through its officially designated "state point of contact," or SPOC. However, the official could not identify California's SPOC and phone calls to state offices also could not turn up a name.

The process being used by Methanex is not unprecedented, although it has most often been used by U.S. companies against what they see as unfair foreign regulation. In the only other case brought against the United States under NAFTA's Chapter 11, a Canadian company is fighting a Mississippi court judgment that cost it $500 million, the trade official said. He suggested the government may have been caught unawares by the Methanex challenge.

"I don't think anyone believed the expropriation protections in NAFTA would be used to challenge environmental regulations in the way Methanex has done," he said.

But in another case with strikingly similar facts to the Methanex challenge, a U.S. company, Ethyl Corp., successfully fought Canada's 1997 ban on the import of the fuel additive MMT into that country. Ethyl brought a $250 million expropriation claim under NAFTA and the Canadian government settled the dispute by paying the company a reported $13 million, rescinding the ban and issuing a statement that it did not have sufficient evidence to prove the chemical was harmful.

That case has led to warnings that a full-scale assault by foreign corporations on environmental laws in countries in which they do business could be under way. Provisions similar to the NAFTA expropriation clause are even now being discussed for inclusion in other worldwide trade agreements, said the Sierra Club's Seligman.

He said a major concern in the new case will be that the federal government reaches a settlement with the Canadian company that legitimizes the use of the expropriation rules for challenging environmental laws, allowing American companies to do the same in other countries.

He also scoffed at government protestations of ignorance about the implications of the expropriation rules, saying environmentalists had warned about those "obscure and outrageous provisions of NAFTA" years ago. "We seemed loony when we said NAFTA allowed companies to sue countries over legitimate environmental regulation," Seligman said.