The “other” Chapter 11

Most readers of Building magazine will not instantly be able to ascribe a meaning to Chapter 11 since it is not a term which comes up often in the construction and development industry. Those in the industry who deal with cross-border projects or who have investors from or investments in the U.S. (and that is becoming more frequent by the day) or who simply follow American financial news will, however, recognize the term Chapter 11 as a form of bankruptcy protection that debtor companies can get under the U.S. Bankruptcy Code in order to provide them with the time and resources necessary to restructure before the company is formally bankrupted.

Alas, while bankruptcy protection and the construction and development industry unfortunately go hand-in-hand (remember the early 1990s?), there is another Chapter 11 that is already beginning to have a significant influence on current and proposed construction and development projects. In a process that sees local and provincial authorities vested with (and unafraid to use) a frightening array of official plans, zoning designations, development charges, and other land use regulations, some enterprising builders and developers are beginning to see a very useful tool in, of all things, Chapter 11 of the North American Free Trade Agreement.

Builders and developers are all too aware of NAFTA’s impact on the profitability of construction and development, but typically such awareness has been limited to the cost and timing implications of seemingly perennial trade disputes such as the cross-border shipment of softwood lumber. Although part and parcel of a trade agreement (which now also includes Mexico), Chapter 11 of NAFTA does not address trade disputes per se. Instead, Chapter 11 of NAFTA is a set of rules designed to limit or curb the powers of a local government to expropriate domestic investments made by citizens of another signatory country (whether directly or indirectly through oppressive and unfair land use restrictions that retroactively make a project prohibitive or impossible).

It is widely accepted that the introduction of Mexico to what had previously been the bi-lateral free trade agreement between the U.S. and Canada spurred the sudden need to add something like Chapter 11 to the trade agreement. It was felt that there was a need to provide the Mexican government with some sort of a hammer to prevent it from just taking, with impunity, whatever it wanted from Canadians and Americans investing in projects within their borders. Such conduct was made illegal by Chapter 11 and could be enforced against the federal government of the offending government (even though a municipality or state was the municipal level of government doing and benefiting from some act of expropriation).

In many ways, Chapter 11 might be credited with having avoided “nationalizations” like the ones that are happening in the oil and gas industries in Venezuela and Russia (although, curiously, in the summer of 2006, the government of Newfoundland and Labrador threatened to seize any yet undeveloped Hebron oilfields off the coast of Labrador in a move that many have labeled “Chavez-esque”).

That said, there have been a number of somewhat subtler incidents that have been “tantamount to expropriation” and for which the member countries have all been called to task. Many of these incidents involve local planning authorities that oppressively and unfairly regulate against certain projects, often to the point of making them economically impossible. It is in this series of what are known as “Investor-to-State” cases that the true effectiveness of Chapter 11 is most clearly manifested.

Arguably the most famous Investor-to-State case to date pitting developers against local land use planning authorities related to a local Mexican municipality that tried to save a rare species of cactus by cancelling a California company’s right to operate an existing landfill site within the range of that rare cactus. By applying Chapter 11, a NAFTA tribunal found that the municipality’s conduct was unfair and tantamount to an expropriation of the American investment in the landfill site, and that the Mexican government (the federal Mexican government) was therefore liable for the damages resulting from such de facto expropriation.

Building magazine readers might think that these types of de facto expropriations might be a real risk only in places like Mexico, and that such risks are not realistic here in Canada. Curiously, nothing could be further from the truth! Recently, the Pennsylvania firm that indirectly owns the Adams Mine site near Kirkland Lake filed a Investor-to-State case against Canada claiming compensation for $355 million in damages after the Province of Ontario passed legislation in 2004 to prevent the Adams Mine site from becoming a repository for Toronto landfill, notwithstanding that the site had already received all requisite environmental approvals required by the previous government in power. Nor is it the first time that the current Ontario government has conducted itself in a manner tantamount to expropriation – readers will remember Ontario’s ill-conceived proposal to try and re-designate the entire Oak Ridges Moraine as a greenbelt without compensation to the many developers, builders and homeowners that had already received or were in a position to receive valid building permits.

While the result of the Adams Mine Investor-to-State case might ultimately cost Canadian taxpayers dearly (and, like in the Mexican case, it is the federal government that must answer the lawsuit, notwithstanding that it was the Province of Ontario that unfairly expropriated the investor’s interest), it is difficult not to be sympathetic to the U.S. investors under the circumstances.

Developers and builders throughout the country (and their respective lenders) are only now opening their eyes to the potential effectiveness of Investor-to-State lawsuits under Chapter 11 of NAFTA. Unfortunately, the right to initiate an Investor-to-State lawsuit under Chapter 11 remains limited to U.S. and Mexican developers and their investors with interests in Canadian projects. Paradoxically, this means that a wholly Canadian-owned local developer or builder might, in theory, actually be treated worse in a Canadian domestic project than a U.S.-controlled developer suffering the same unfair treatment.

Of course, Canadian developers and builders crossing south of the 49th parallel will enjoy a corresponding advantage over domestic U.S. and Mexican developers in like manner, but it would not surprise this author if more and more domestic Canadian projects will eventually involve much more U.S. interests (both because of the increasing ease of raising cross-border capital and financing, and because of the added benefit of gaining standing to bring Investor-to-State cases). This is especially true where the projects are large and susceptible to political risk. In this regard, just about any of the so-called “P3” projects or any other large infrastructure works come to mind immediately, but given the actions of both Ontario and Newfoundland of late, no project can truly be safe from “tantamount expropriation.”

The Investor-to-State lawsuit is still a relatively novel legal process (many Canadian real estate lawyers barely realize what Chapter 11 is let alone are able to initiate an Investor-to-State lawsuit), but especially if the case regarding the Adams Mine is successful, we can expect to see many more Investor-to-State lawsuits involving projects cratered by governmental unfairness in the land use planning process.

While some commentators worry that Chapter 11 undermines the democratic process by preventing elected municipal and provincial governments from doing as they please, this author believes that, if the Investor-to-State lawsuits under Chapter 11 of NAFTA help even slightly in curbing municipal and provincial conduct that is tantamount to expropriation without correspondingly fair compensation, then it is a good thing to have around for the develo
pment and construction industry.

Jeffrey W. Lem, B.Comm. (U of T), LL.B. (Osgoode), LL.M. (Osgoode), practises in the areas of commercial real estate and finance with the law firm of Davies Ward Phillips & Vineberg LLP and has been called to the bar in Ontario and in England and Wales. He is an executive member of the Real Property Section of the Ontario Bar Association, and an editor-in-chief of the Real Property Reports, published by Carswell Thomson Professional Publishing.

This article provides general information only and is not intended to provide specific legal advice. Readers should not act or rely on information in this article without seeking specific legal advice on their particular fact situations.

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