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Under the USMCA, Mexico has until October 3, 2022, to resolve the disagreements with the U.S. and Canada via consultations.  (Photo: US Embassy, Mexico)
Margarita R. Sánchez, Richard A. Mojica and Mary H. Mikhaeel, Miller & Chevalier. (Latinvex collage)
Wednesday, September 14, 2022

USMCA Dispute: Arbitration Avenues Narrow Soon

International arbitration avenues for U.S. investors in Mexico to narrow soon.


In July 2022, the U.S. and Canada announced they had requested dispute settlement consultations with Mexico under Chapter 31 of the United States-Mexico-Canada Agreement (USMCA) related to certain measures that dramatically favor the state-owned electric utility, Comisión Federal de Electricidad (CFE) and the state-owned oil and gas company, Petroleos Mexicanos (Pemex) over foreign investors. 

Foreign investors have heavily participated in the Mexican energy sector since 2013 in response to significant energy reforms during President Enrique Peña Nieto's administration. The historic reforms ended the 75-year-old monopolies held by CFE and Pemex, opened Mexico's energy market for competitive supply, and ultimately positioned Mexico as one of the most appealing markets for foreign investment among other emerging markets. 

Moreover, in 2015, Mexico was among the top 10 destinations in the world for new investments in clean energy, attracting more than $4 billion, with an energy demand growing at approximately three percent per year (residential and industrial consumers).  By 2018, Mexico was one of the top three Latin American countries with the greatest wind and solar energy potential, as well as for geothermal energy, having world's fifth largest geothermal power installed capacity after the U.S., the Philippines, Indonesia, and New Zealand.

From 2014 to 2020, Mexico's energy sector received more than $11 billion in net foreign direct investments from U.S., Canada, and EU investors.  In late 2018, however, after Andrés Manuel Lopez Obrador was elected president, Mexico's energy policies began to shift prioritizing CFE for energy generation over private generation, setting the path for state-owned companies, including Pemex, to dominate the energy market. Additionally, through its regulatory agencies, Mexico began a crusade in 2019 to keep renewable investors out of the market. By June 2022, a significant number of the 50 wind and solar projects proposed by local and foreign investors, representing a potential of almost 7,000 megawatts of renewable energy ("enough electricity to power a city the size of Los Angeles") were awaiting permits as of 2019.

The measures adopted by Mexico since President Lopez Obrador took office, aiming to ensure Mexican energy sovereignty, include:

• Issuance of the Electricity Power Industry Law — as amended — to significantly favor CFE and Pemex over other companies operating in the energy sector

• Inaction, delays, denials, and revocations of private companies' abilities to operate in Mexico, discriminating against U.S and Canadian energy companies, and favoring Mexico's state-owned competitors

• Postponement of requirement to supply ultra-low sulfur diesel for Pemex only, eliminating its need to rely on foreign companies for ultra-low sulfur diesel

• Creation of policies requiring Mexico's gas transportation network to source from Pemex or CFE

These measures are the basis for the U.S.'s and Canada's consultation requests. 

Current Status and Likely Outcomes from the USMCA Consultations

The first round of consultation between the U.S. and Mexico, along with Canada, took place in August 2022.

Under the USMCA, Mexico has until October 3, 2022, to resolve the disagreements with the U.S. and Canada via consultations. If there is no resolution by the deadline, the U.S. and Canada can request the establishment of a dispute settlement panel, eventually leading them to adopting retaliatory measures against Mexico. The panel has 150 days to present an initial report to the parties, who will have the opportunity to submit written comments. The panel will then issue its final report, which will be made public and outline the panel's recommendations, approximately 200 days later. Finally, the report must be implemented 45 days after it is issued.

The parties must come to an agreement as to what Mexico's resolution will entail. The resolution may include: "an elimination, nullification, or impairment of the non-conforming measurements; mutually acceptable compensation; or another remedy upon which the parties have agreed." If the parties are unable to agree on a resolution, U.S. and Canada may suspend certain benefits afforded Mexico equivalent to those which Mexico is depriving the U.S. and Canada as a result of its energy policies.  

While Mexico has participated in inter-state negotiations in the past and has expressed willingness to sustain an open dialogue with the U.S. and Canada over the energy disputes, President López Obrador recently called the U.S. consultation process "complete nonsense." By contrast, U.S. Trade Representative (USTR) Katherine Tai noted that the U.S. has "repeatedly expressed serious concerns" about the practices covered by the U.S.'s consultation request. U.S. investors (who soon will face fewer protections for dispute resolution under the USMCA and may need to rely more heavily on the USMCA's state-to-state dispute resolution mechanism) are supportive of the U.S.'s decision to bring a claim, because they have suffered the effects of Mexico's policies on their businesses. 

U.S. and Canadian Investors Should Closely Follow the Evolution of the USMCA Consultations and Be Ready to File a Notice of Intent Against Mexico by April 1, 2023, to be Covered by NAFTA Chapter 11

Although the USMCA consultations may provide a clear path to resolving some of the concerns raised by the U.S. and Canada as a result of Mexico's new energy policies, U.S. and Canadian investors should assess the implications of the USCMA's inter-state process to their financial and commercial interests and evaluate strategies to seek relief for the damages that could be done to their investments in Mexico using the USMCA's predecessor: the North America Free Trade Agreement (NAFTA), which offers broader substantive protections to investments. The USMCA consultation processes do not prevent foreign investors to begin international investment arbitration. Annexes 14-C, 14-D, and 14-E of USCMA allow investor-state arbitration under certain circumstances, including under 'legacy investments' pursuant to NAFTA Chapter 11.

NAFTA legacy investments are investments in the territory of the U.S., Mexico, or Canada, established or acquired during the NAFTA treaty period (January 1, 1994 - July 1, 2020), that were still in existence at the time the USMCA went into effect on July 1, 2020. Under Annex 14-C, investors from the U.S., Canada, and Mexico may still use NAFTA's Chapter 11 for these legacy investments so long as they begin arbitration proceedings against the host state within the window of three years of NAFTA's termination date (July 1, 2022).

The deadline for submitting a notice of intent and subsequent request for arbitration pursuant to USMCA is fast approaching. Pursuant to NAFTA's Article 1119, a party shall deliver the respondent a written notice of its intent to submit a dispute to arbitration at least 90 days before submitting the claim. Therefore, to preserve their ability to bring NAFTA legacy claims against Mexico by the USMCA deadline, U.S. and Canadian investors shall deliver their notice of intent by April 1, 2023.

As noted above, the timeline for the U.S.'s and Canada's consultation process can trail to over 200 days. U.S. and Canadian investors should closely follow the evolution of the USMCA consultations and be ready to file a notice of intent — which does not bind a claimant to eventually initiate investment arbitration proceedings — lest they miss the deadline.

Certain investors should be particularly aware of their rights under NAFTA and the USMCA and diligent in taking active steps to determine whether they have potential claims against Mexico and minimize intrusion to their investments. These include:

Canadian Investors with Investments in Mexico. Canada has completely withdrawn from Investor-State Dispute Settlement (ISDS). Therefore, while Canadian investors may still have access to State-State Dispute Settlement (SSDS) and ISDS under the Comprehensive and Progressive Trans-Pacific Partnership (CPTTP), after July 1, 2023, they will be unable to bring claims against the U.S. or Mexico using USMCA's ISDS mechanism with respect to NAFTA legacy investments. Also, like the USCMA, the CPTTP is less investor-friendly than NAFTA.

U.S Investors with Investments in Mexico Who Do Not Have a "Covered" Government Contract and Operate in a "Covered Sector." Unlike NAFTA, under the USMCA, investors under "covered government contracts" in "covered sectors" are privileged over other investors. Pursuant to Annex 14-E, U.S. investors who have a covered government contract in certain sectors, including oil and natural gas production, electricity generation, telecommunications, transportation, and certain infrastructure investment, will enjoy broader access to ISDS and protections. Investors that do not fall under this category will not enjoy USMCA's favorable regime. 

Notably, investors may find that due to the USMCA's procedural limitations, or truncated grounds under which an investment claim can be brought, they may no longer be able to bring a claim under the USMCA after the NAFTA legacy investment provision deadline or that their claim may be more restricted. Foreign investors in Mexico who cannot use the NAFTA legacy investment provision or the USMCA ISDS mechanism may consider whether other free trade agreements or bilateral investment treaties may provide a pathway for relief.  

Margarita R. Sánchez is International Arbitration Practice Lead at Miller & Chevalier, Richard A. Mojica is Customs & Import Trade Practice Lead at Miller & Chevalier and Mary H. Mikhaeel is an Associate in the International Department at Miller & Chevalier.

Republished with permission from a client overview by Miller & Chevalier.



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