Nafta To The Rescue?

It may shield investors from political cross fire

In a mountain valley studded with cactus and mesquite scrub, Mexico's first modern hazardous-waste landfill sits unused. Built two years ago, it was intended to be a model for efforts to clean up Mexico's degraded environment. Instead, it has become a symbol of how investments can turn sour in Mexico--and how investors can seek protection under a shield created by the North American Free Trade Agreement.

Local authorities opposed the landfill's opening in the central state of San Luis Potosi. But California's Metalclad Corp., which built the facility with backing from Mexico's federal government, is filing for compensation under NAFTA. A little-known provision of the accord gives investors from NAFTA countries the right to take claims against the three governments to arbitration by a multinational panel. Metalclad's case, the first of its kind, promises to set a precedent for others. "If we win this NAFTA suit, it's going to wake everybody up to the idea that if you want foreign investment, there are strings attached--equal protection and due process," says Metalclad President Grant S. Kesler.

The suit is also likely to underscore how NAFTA's provisions may come back to haunt its members. NAFTA's investor protections--stronger than those for worker rights and the environment--provide a recourse that may circumvent domestic courts. In Mexico's case, these are notoriously slow, corrupt, and politicized. "Before, the federal government and the PRI [the ruling Institutional Revolutionary Party] could keep control outside the law," says Sergio Lopez Ayllon, a NAFTA legal expert at the National Autonomous University of Mexico. "Now the law will have to be applied with more clarity."

But rulings by the arbitrators--Metalclad's three-member panel comprises former U.S. Attorney General Benjamin R. Civiletti and prominent jurists from Mexico and Britain--also could fan opposition to NAFTA. That will be particularly true if the perception grows that an outside body is riding roughshod over domestic legal practices.

In Mexico, the fast-changing political scene creates pitfalls for investors as states and local communities win powers once tightly held by the federal government. Metalclad, a Newport Beach (Calif.) company with annual revenues of $20 million, reported a first-quarter loss of $1.2 million. It is seeking $50 million in compensation, arguing that the landfill was expropriated and the company did not receive the same treatment as a national investor. Another claim has subsequently been filed by Los Angeles investors who spent $3 million on a municipal garbage concession that was revoked by a new mayor. Also seeking redress under NAFTA is Ethyl Corp., based in Richmond, Va. A new Canadian law has blocked sales of a fuel additive that Ethyl has sold there for 20 years, and the company wants $250 million compensation from the government.

GREEN GRIPES. Metalclad, drawn by Mexico's growing environmental market, bought its landfill site in 1993 from a Mexican company that had illegally dumped hazardous waste in the area. The project was expected to set an example of how to manage Mexico's 8 million tons of such waste each year, most dumped or buried illegally. Despite permits from the federal and state governments--issued, in the latter case, by an outgoing governor--Metalclad ran into local opposition from the impoverished community of Naucalpan. Residents pointed to 55,000 drums of waste left by the earlier company and said they wanted no more. The new state governor backed local environmental groups and Greenpeace Mexico, which warned that Metalclad's landfill would pollute the water supply and endanger rare cacti. Metalclad went ahead and built the $20 million landfill, assured by federal authorities that final jurisdiction lay with the federal government. But its case is hurt by lack of a local permit.

More complaints under NAFTA are likely as Mexico adjusts to a new balance of federal and local powers. "Over the next half-dozen years, we may see hundreds of cases," predicts Metalclad's lawyer Clyde C. Pearce. But already, for officials and investors alike, the first case is emphasizing the letter of the law--in lieu of Mexico's traditional unwritten rules.