25 July 1983

1.1 In a communication dated 5 January 1982, the United States requested the government of Canada to consult under Article XXII:1 on the administration of the Canadian Foreign Investment Review Act. Among the issues which the United States wished to raise in the consultation was the practice of the government of Canada to enter into agreements with foreign investors according to which these are to give preference to the purchase of Canadian goods over imported goods and to meet certain export performance requirements. The communication was circulated to the contracting parties on 7 January 1982 (L/5280). Since the consultation did not lead to a solution, the United States, in a communication dated 19 March 1982, referred the matter to the CONTRACTING PARTIES in accordance with Article XXIII:2 (L/5308).

1.2 At its meeting on 31 March 1982 the Council agreed to establish a Panel and authorized its Chairman, in consultation with the two parties concerned and with other interested contracting parties, to decide on appropriate terms of reference and, in consultation with the two parties concerned, to designate the Chairman and the members of the Panel.

1.3 At the meeting of the Council on 2 November 1982 the Chairman of the Council informed the Council that these consultations had been held and that the following composition and terms of reference had been agreed:

Composition

Terms of Reference

1.4 At the Council meeting, a number of delegations expressed doubts whether the dispute between the United States and Canada was one for which the GATT had competence since it involved investment legislation, a subject not covered by the GATT. They therefore reserved their position on the terms of reference (C/M/162, pages 25-26). The representative of the United States said that his government was not calling into question the Canadian investment legislation as such but was complaining about the two specific trade-related issues mentioned in the terms of reference. The representative of Canada said that, in the view of his government, the terms of reference ensured that the examination would touch only on trade matters within the purview of GATT. The Chairman suggested, and the Council so decided, that the terms of reference remain as they stood, that the reservations and statements made be placed on the record and that it be presumed that the Panel would be limited in its activities and findings to within the four corners of GATT.

1.5 The representatives of the contracting parties which had spoken on the matter in the Council were asked by the Chairman of the Panel, in letters dated 20 December 1982, whether they wished to have an opportunity to be heard by the Panel as provided in paragraph 15 of the Understanding Regarding Notification, Consultation, Dispute Settlement and Surveillance (BISD 26S/213). Argentina asked to be given this opportunity and was heard by the Panel on 25 January 1983. (The views of Argentina are summarized below in paragraphs 4.1 and 4.2).

2.1 The following description of the factual aspects, particularly in paragraphs 2.3, 2.5, 2.7 and 2.12, contains much information about the Foreign Investment Review Act which is not directly at issue in this dispute but is useful in placing the dispute in its general context.

2.2 The Foreign Investment Review Act. In December 1973 the Parliament of Canada enacted the Foreign Investment Review Act. According to Section 2(1) of this Act, the Parliament adopted the law "in recognition that the extent to which control of Canadian industry, trade and commerce has become acquired by persons other than Canadians and the effect thereof on the ability of Canadians to maintain effective control over their economic environment is a matter of national concern" and that it was therefore expedient to ensure that acquisitions of control of a Canadian business or establishments of a new business by persons other than Canadians be reviewed and assessed and only be allowed to proceed if the government had determined that they were, or were likely to be, of "significant benefit to Canada".

2.3 Section 2(2) lists five factors to be taken into account in assessing whether a proposed investment is or is likely to be of significant benefit to Canada. These are:

2.4 Written undertakings given by investors. The Act provides that investors may submit written undertakings on the conduct of the business they are proposing to acquire or establish, conditional on approval by the Canadian government of the proposed acquisition or establishment. The submission of undertakings is not required under the Act but, as the administration of the Act evolved, they are now routinely submitted in support of nearly all larger investment proposals. Many undertakings are the result of negotiations between the investor and the Canadian government. Undertakings given by investors may deal with any aspect of the conduct of a business, including employment, investment, research and development, participation of Canadian shareholders and managers, productivity improvements as well as practices with respect to purchasing, manufacturing and exports. There are no pre-set formulas or prescriptions for the undertakings.

2.5 Purchase undertakings. Undertakings with respect to the purchase of goods have been given in a variety of forms:

Undertakings on purchases are often but not always conditional on goods being "available", "reasonably available" or "competitively available" in Canada with respect to price, quality, and delivery or other factors specified by the investor.

2.6 Manufacturing undertakings. Some firms have given undertakings to manufacture in Canada products or components of a product used or sold by the firm.

2.7 Export undertakings. The undertakings involving the export of goods have been given in a variety of forms:

2.8 Statistics on the undertakings. The Act came into force on 9 April 1974 with respect to acquisitions and on 15 October 1975 with respect to new businesses. From April 1974 to September 1982, the Government of Canada has rendered decisions on 4,103 investment proposals, of which 2,448 were from the United States. Approximately 90 per cent of the reviewable investment proposals on which the government has taken a decision have been judged to be of significant benefit to Canada and have, therefore, been allowed. The Panel asked questions about the frequency with which the various types of undertakings have been given. In order to answer these questions the Canadian government reviewed a sample of 181 investments allowed in the month of November in the years 1980, 1981 and 1982. (November was the latest month for which data were available). In this sample, 55 of the investors or 30 per cent of the total gave no undertakings relating to sourcing. The remaining 126 investors gave a total of 178 sourcing undertakings. (Some investors gave more than one sourcing undertaking). Of those 178 sourcing undertakings, 65 per cent referred to the purchase of goods and services from Canadian suppliers or words to that effect, 15 per cent referred to purchase of Canadian produced goods. The remaining 20 per cent were sourcing commitments of other kinds, e.g. to set up a Canadian purchasing division, or to consult with a government body to identify potential Canadian suppliers. This latter 20 per cent also includes undertakings relating solely to the purchase of services. 71 per cent of the undertakings to purchase in Canada or to purchase Canadian produced goods carried a qualification with respect to the availability of goods on competitive terms.

2.9 With respect to export undertakings in the same sample of 181 investments, 97 investors or 54 per cent of the total gave no export undertakings of any kind. The remaining 84 investors gave 96 export undertakings. (Again some investors gave more than one undertaking relating to exports). Of the 96 export undertakings, 32 per cent referred to a quantifiable level of exports, e.g. target value of exports or a percentage of output. The remaining 68 per cent were export undertakings of other kinds, such as an undertaking not to restrict the export activities of the Canadian business, or to actively pursue export opportunities.

2.10 Enforcement of the undertakings. Written undertakings given by firms are legally binding on the investor if the investment is allowed. According to Section 21 of the Act the Minister responsible for the administration of the Act may apply to the courts for a remedial order in the event an investor fails to implement undertakings he has given. The Minister responsible for the Act made the following statement in the Canadian Parliament in 1973 on the enforcement of undertakings:

2.11 All investments that are allowed subject to the Act are monitored by the government of Canada. If the investment involves specific undertakings the investor is asked at regular intervals for a progress report on the implementation of his undertakings. All undertakings are monitored at least once before the file is closed, normally after the fifth anniversary of the date on which the permission to invest was granted. If the investor's progress report reveals a variation from the undertakings, or non-fulfilment of them, the investor is asked to provide a more detailed explanation. Depending on the circumstances, performance of unfulfilled undertakings has so far always been either postponed or waived, or the undertakings have been replaced by revised undertakings. To date, the Minister responsible for the administration of the Act has not applied to the courts to enforce an investor's written undertaking.

2.12 Recent changes in the administration of the Foreign Investment Review Act. During the second half of 1982 some changes were introduced in the administration of the Foreign Investment Review Act, without entailing modifications in the Act itself. Among the most important changes was the decision to raise the threshold for the review of new investments or direct acquisitions under the small business procedures from Can$ 2 million and 100 employees to Can$ 5 million and 200 employees. The small business procedures do not require a full review, except under special circumstances. Approximately, 85 per cent of all proposals fall within the small business procedure.

3.1 The United States requested the Panel to find that the written undertakings obtained by the Government of Canada under the Foreign Investment Review Act which oblige foreign investors subject to the Act

are inconsistent with Articles III:4, III:5, XI and XVII:1(c) of the General Agreement, and that the undertakings which oblige foreign investors

are inconsistent with Article XVII:1(c) of the General Agreement, and that any such undertakings therefore constitute a prima facie case of nullification and impairment under Article XXIII of the General Agreement. The United States further requested the Panel to suggest that the CONTRACTING PARTIES recommend that Canada (a) make clear that it will not regard as binding, or seek to enforce in the context of the Foreign Investment Review Act, any undertaking of the kind found to be inconsistent with the General Agreement, and (b) that it cease eliciting and accepting such undertakings as part of investment proposals.

3.2 Canada requested the Panel to find that the purchase undertakings (paragraph 3.l(a)) given by foreign investors are not inconsistent with the provisions of Articles III:4, III:5, XI or XVII:1(c) of the General Agreement, that the export undertakings (paragraph 3.1(c) ) are not inconsistent with the provisions of Article XVII:1(c) and that, were the purchase and/or export undertakings to fall within the provisions of one or more of these Articles, they, would constitute measures within the provisions of Article XX(d). As to the manufacturing undertakings (paragraph 3.1(b)), Canada asked the Panel to find that these do not fall under the Panel's terms of reference.

3.3 Both parties agreed that the issue before the Panel was not the Foreign Investment Review Act itself or Canada's right to regulate the entry and expansion of foreign direct investments, but rather the consistency with the General Agreement of the purchase and export undertakings given by investors subject to the Foreign Investment Review Act.

3.4 Article III:4. The United States contended that the written undertakings which oblige investors to purchase goods of Canadian origin in preference to imported goods or in specified amounts or proportions, or to purchase goods from Canadian sources (henceforth referred to as "purchase undertakings") violated Article III:4 because they constituted requirements giving less favourable treatment to imported products than to like products of national origin.

3.5 In the view of the United States even those undertakings that obliged a firm to purchase goods in Canada whenever "available", "reasonably available", or "competitively available" had the effect of according less favourable treatment to imported goods. Such undertakings prevented the investor from choosing freely between imported and domestic goods since they obliged him to opt in favour of domestic products whenever the availability condition was fulfilled. The provisos "reasonably available" or "competitively available" were vague and involved value judgements regarding quality, reliability of supply and the like. A firm subject to an undertaking with such a proviso was therefore likely to purchase Canadian goods even when they were less attractive than imported goods in order to avoid possible conflict with Canadian officials monitoring compliance who have a different perspective and apply different value judgements on these matters. Undertakings to purchase from Canadian sources or suppliers (whether the products purchased were domestic or imported) would also result in less favourable treatment to imports than that given to Canadian products because in cases where a product was produced in both Canada and other countries such undertakings would oblige the investor to purchase imports from a Canadian "middleman" (the importer/distributor/retailer), thus forcing the investor to incur additional costs in the form of the middleman's profit if he decided to import, but leaving him free to purchase directly from a Canadian manufacturer, thereby avoiding the additional cost of the "middleman". Even more discrimination against imported products would result in instances in which Canadian sources and suppliers did not stock or distribute imported products sought by the investor.

3.6 Canada held that the purchase undertakings did not constitute laws, regulations or requirements within the meaning of Article III:4. There was no provision in the Foreign Investment Review Act, its regulations or any other Canadian act or regulation which stipulated that any undertaking shall be given by a firm as a condition of investment. While there was an overall requirement under the Act that a foreign investor demonstrate that his proposal, as an overall package, was, or was likely to be, of significant benefit to Canada, it was entirely up to him to choose the means to do this. Frequently, investors chose to offer purchase undertakings in support of their proposals. Canada further stated that the investment screening procedures were not intended nor applied so as to provide protection to Canadian manufacturers or to oblige companies to depart from commercially sound practices. Investors, having decided on their plans for conducting business in Canada, generally had no hesitation in giving undertakings which reflected these plans. Since both the investor and the Canadian government had to act in the context of markets in which the investor's competitors were not subject to undertakings, it was highly unlikely that purchase undertakings would either be offered or sought that departed significantly from the purchasing practices the investor would follow in the absence of the undertaking. Where undertakings were given, they reflected a decision by the investor about how he intended to conduct his business in Canada. Undertakings would only represent a cost to the investor if they did not reflect his business intentions. When investors gave purchase undertakings without any qualification as to the competitive availability of goods in Canada, it was usually because either the investor had already identified his sources of supply, or, given the nature of his business, purchases were ordinarily made locally. A review of the circumstances of the investment proposals specifically cited by the United States in their submission did not support the claim that the undertakings given in these proposals had to be regarded as requirements.

3.7 The United States replied that it was true that the Act itself did not require investors to offer undertakings, but, once given, the undertakings had to be regarded as requirements in the light of the circumstances in which they were offered and accepted and of their legally binding character. No private business would bind its future purchasing practices unless the achievement of some benefit or the avoidance of some penalty was made contingent upon that binding. The investors only offered undertakings in order to obtain the Canadian government's approval of their investment proposals. Moreover, there were many cases in which purchase undertakings were the result of negotiations in which Canada sought new or "improved" undertakings. The government of Canada itself had indicated that most of the work performed by the Foreign Investment Review Agency established under the Foreign Investment Review Act centred on the effort to define and to improve the terms of the original investment proposals¹. Once the investment proposal had been approved, the undertaking became legally binding on the investor, who was then no longer free to modify his purchase undertaking without the permission of the government of Canada, regardless of changed circumstances. In the current economy it was difficult to imagine that a company would not alter plans it had made more than a year before unless the alteration of those plans entailed a greater penalty than adherence to them. The threat of legal action and the potential effect of non-compliance on future requests for permission to invest was not lost on enterprises that had given undertakings. Canada replied that, although undertakings were not required, where an investment was allowed which contained undertakings it was both reasonable and necessary for the Canadian government to have a means by which remedial action could be taken in the event an investment was implemented in a manner inconsistent with the authority granted. Enforceability under the law simply held the investor, after he had given the undertaking, to doing what he said he would do. Enforceability served to discourage the presentation of grandiose or inflated statements by the investor of his intentions so as to secure approval of his proposal.

3.8 Canada, citing the panel reports in BISD 7S/60 and 25S/49 as precedents, stated that the word "requirements" in Article III had to be interpreted in conjunction with the terms "laws and regulations" and in this context it should be defined as a mandatory rule of general application applying across-the-board to a particular product or range of products. The undertakings, however, were private contractual obligations of a particular foreign investor. They applied to a specific investment and not to trade in goods generally. The United States replied that the exercise of many governmental functions, and the grant of many benefits within a government's power, could be viewed, or recast to appear, as "private contracts" between firms and the government. To find that such "private contracts" were not requirements within the meaning of Article III would be to invite contracting parties to do by "private contract" what the General Agreement did not permit to be done by laws of general application. There was no basis in the General Agreement or in previous panel reports for asserting that only across-the-board measures applying to purchases of all products of a certain category were subject to GATT obligations.

3.9 Canada stated that the word "requirements" in Article III:4 of the General Agreement should be interpreted in the light of Article 12 of the Havana Charter, which reads in part: "The Members recognize that ..., without prejudice to existing international agreements to which Members are parties, a Member has the right... to determine whether and to what extent and upon what terms it will allow future foreign investments, to prescribe and give effect on just terms to requirements as to the ownership of existing and future investments and to prescribe and give effect to other reasonable requirements with respect to existing and future investments". The drafting history of the General Agreement revealed that it was the intention of the drafters of the General Agreement that the extent of the rights and obligations under the General Agreement were to be consistent with, and defined within the broader context of, the Havana Charter. The draftsmen were working within a conceptual framework that encompassed both trade and investment, and rights and obligations with respect to both. GATT Article III was amended in 1948 to incorporate the text of the Havana Charter on national treatment. Canada was not arguing that the Havana Charter was in force but rather that one could not read into the General Agreement obligations which the drafters of the General Agreement had not intended it to contain. Given that it was agreed that the provisions of the Havana Charter were to be interpreted as a consistent whole, it was reasonable to conclude that the meaning of the word "requirements" in the Charter's national treatment provision corresponding to Article III of the General Agreement did not encompass "requirements as to ownership" or "other reasonable requirements" allowed under the Charter's investment provisions. Although the Chapter of the Charter dealing with investment was not incorporated into the General Agreement, it was one of the Chapters the general principles of which the contracting parties, in Article XXIX of the General Agreement, agreed to observe to the fullest extent of their executive authority pending the ratification of the Charter. It was therefore reasonable to assume that it had not been the intention of the drafters of the a General Agreement to include within the meaning of the words "requirements" in Article III of the General Agreement those "requirements" provided for under Article 12 of the Havana Charter. Thus, if the Panel were tending towards an interpretation that undertakings were requirements, which in Canada's view they were not, they would be requirements within the meaning of Article 12 of the Havana Charter.

3.10 The United States replied that Canada was asking the Panel to decide that a provision in a draft agreement which never entered into force be interpreted to override specific obligations of the GATT. The Havana Charter provisions on investment, had they entered into force, would most likely not have been interpreted to override the Charter's national treatment obligation. A broad range of requirements - for instance those relating to the employment of nationals, to management, etc. - could be imposed without conflict with the obligation to grant to imported products no less favourable treatment than to products of domestic origin. As a matter of common sense and normal interpretation of an international agreement, the requirements that were contrary to another specific obligation of the Charter would not have been interpreted to be a "reasonable" requirement within the meaning of the Charter's investment provisions.

3.11 The United States pointed out that, after the Charter had been abandoned, Article III had been amended but not to exempt trade-related requirements affecting foreign investors. Canada replied that Article III was last amended in 1948 whereas Article XXIX went into force in 1952.

3.12 Article III:5. The United States contended that purchase undertakings which obliged the investor to purchase in Canada a specified amount or a proportion of his requirements constituted internal quantitative regulations relating to the investor's processing and use of products and that they were therefore contrary to Article III:5. Canada stated that the Foreign Investment Review Act did not establish any internal quantitative regulations. In the relatively few cases in which investors had given purchase undertakings that referred to specific amounts or proportions of the investors requirements, the figures mentioned reflected the investor's expectations. Regulations were, in the view of Canada, subsidiary rules of general application promulgated by the executive pursuant to an existing legislative enactment. The word "regulations" in Article III:5 involved a rule of general application as was the case in the previous Panel reports which involved Article III:5 (BISD 11S/95 and 25S/49). The purchase undertakings were firm-specific and did not relate generally to the international trade of the goods in question; they could therefore not be regarded as "regulations" within the meaning of Article III:5. The United States replied that each undertaking obviously did not, by itself, have the same degree of effect as a general regulation applicable to an entire industry. But the effect of such undertakings was to restrict the internal market for various imported products by requiring individual firms to use specified amounts or proportions of Canadian products.

3.13 Article XI. The United States claimed that the purchase undertakings operated as restrictions on the importation of products into Canada and were therefore contrary to Article XI. In the view of Canada there was a fundamental distinction in the General Agreement between measures affecting the importation of products and measures affecting imported products. The former were regulated by Article XI which clearly spoke of "importation" and the latter by Article III which referred to "imported products". If Article XI were interpreted to cover also internal measures affecting imported products Article III would have no function. The United States said that, though Article XI was primarily aimed at traditional import quota systems, the language of the Article was broad enough to cover also other, similarly restrictive non-tariff barriers not implemented or enforced at the border. In the United States' view the purpose of the undertakings was to limit imports and reserve a portion of the internal market for Canadian products, which Article XI was intended to prohibit.

3.14 Article XVII:1(c). The United States asserted that the purchase undertakings prevented the investors from acting solely in accordance with commercial considerations and that they therefore violated Canada's obligations under Article XVII:1(c). Canada replied that Article XVII:1 only extended to state-trading and other enterprises the most-favoured-nation principle, and whether or not the investor was prevented from acting in accordance with commercial considerations was therefore irrelevant given the meaning of this Article. A careful research which Canada had undertaken into the drafting history had revealed no reference to national treatment in the discussions leading to the adoption of Article XVII:1. Under Article 26 of the United States "Suggested Charter for an International Trade Organization of the United Nations", which served as a basis for the London Conference in October-November 1946, state-trading enterprises were to accord "non-discriminatory treatment, as compared with the treatment accorded to the commerce of any country other than that in which the enterprise is located." At the London Conference the non-discrimination obligation was reformulated to read: "... the commerce of other Members shall be accorded treatment no less favourable than that accorded to the commerce of any country, other than that in which the enterprise is located... ". The formulation of the non-discrimination obligation contained in Article XVII went back to a draft adopted at the 1947 Geneva Conference. If the drafting changes introduced then had been intended to include the national treatment obligation in the provisions on state-trading, this fundamental change would have been referred to in the extensive records of the drafting sessions. One reference to the Article on state-trading in the records of the Geneva Conference (E/PC/T/A/SR/10, page 34) confirmed in the view of Canada that this Article was understood to establish only a most-favoured-nation obligation: a delegate had said in a discussion on government procurement that the Article on state-trading referred only "to most-favoured-nation treatment and not to national treatment" and had then proposed that, in drafting rules on government procurement, "you have got to stick to most-favoured-nation treatment as you have in state-trading."

3.15 The United States stated that it disagreed with the Canadian interpretation for two reasons. First, paragraph 1(a) spoke of principles of non-discriminatory treatment. Were the most-favoured-nation principle the only principle intended to be covered, the word principle would not have been used in the plural. Second, paragraph 2 of Article XVII would be unnecessary if the most-favoured-nation principle of non-discriminatory treatment were the only principle covered by paragraph 1(a). Paragraph 2 permitted contracting parties to give less favourable treatment to imports in comparison to domestic products when purchasing for the consumption of the government. This exception from the national treatment obligation would be superfluous if the term "principles of non-discriminatory treatment" only covered the principle of most-favoured-nation treatment.

3.16 Canada said that Article XVII:1(b), and the principles of "commercial considerations" and "adequate opportunity to compete" it contained, were intended to define the most-favoured-nation treatment principle with respect to state-trading, contained in Article XVII:1(a). This was made clear by the opening clause of paragraph (b) which read: "The provisions of sub-paragraph (a) of this paragraph shall be understood to require...". The reference to "commercial considerations" in this context permitted a derogation from the most-favoured-nation principle; it did not impose an additional obligation of broad import, as the United States suggested. The obligation in Article XVII:1(c) was that a contracting party shall not prevent any enterprise from acting in accordance with the principles of XVII:1(a) and 1(b). The word principle was used in the plural because the most-favoured-nation obligation in the General Agreement involved a number of principles such as those set out in Article I, Article IV on screen quotas for films, and Article XIII concerning import quotas. In response to the argument that paragraph 2 of Article XVII would be unnecessary if the most-favoured-nation principle of non-discriminatory treatment were the only principle covered by paragraph l(a), Canada stated that a reference in the Geneva Conference to the Article on state-trading (E/PC/T/A/SR/37, page 7) established that paragraph 2 of Article XVII did not involve the national treatment principle. Further evidence of the most-favoured-nation character of Article XVII was demonstrated by the fact that Article XVII:1(a) dealt with the purchases or sales of state enterprises involving either imports or exports. The terms "imports" and "exports" described the process of a product crossing a border and clearing customs. Once the product had entered or left the country, it was an "imported" or "exported" product. (Thus Article III spoke of "imported" products.) The scope of Article XVII was therefore limited to purchases or sales abroad by the state enterprise. It was not concerned with the treatment by the state-trading enterprise of imported or domestic products in its domestic market.

TO CONTINUE WITH ADMINISTRATION OF THE FOREIGN INVESTMENT REVIEW ACT

¹ Proceedings of the House of Commons Standing Committee on Finance, Trade and Economic Affairs of 26 May 1981.