China-U.S. Trade Law : International Trade Lawyer & Attorney : Baker Hostetler Law Firm : Trade Remedies, Customs & Export Controls

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Recent U.S. free trade agreements (“FTAs”) and comments from U.S. government officials suggest that obligations to respect and enforce internationally recognized labor standards could become part of the text offered by the United States for the negotiation of a bilateral investment treaty (“BIT”) with China. The trend of making labor rights more prominent in U.S. FTAs and BITs is likely to continue for agreements currently being negotiated under President Obama and a Congress controlled by the Democratic Party, including the U.S.-China BIT.

         The United States approaches its negotiations of BITs by working from a model text that has evolved from prior BITs and free trade agreements. In 2004, the United States developed a Model BIT that it has used as the basis for negotiating BITs and investment chapters in FTAs. The 2004 Model BIT contains a brief chapter on Investment and Labor providing that the parties may not weaken their domestic labor laws in violation of internationally recognized labor standards to encourage investment in their respective territories.

         Revisions to the 2004 Model BIT were being made last year, and reportedly will conclude with a new Model BIT text to be released by the government sometime during the next three months. The 2010 Model BIT is likely to serve as the foundation for U.S. negotiations of a BIT with China. Administration officials have not stated publicly the extent to which the 2010 U.S. Model BIT will include provisions protecting labor rights, and in some respects it would be logical to reserve agreement on labor rights for FTAs. FTAs cover a much wider range of policy issues than BITs, and application of international labor standards is more comprehensible in the context of agreements specifically addressing trade.

         Despite the logic, there are indications that the revised 2010 U.S. Model BIT is likely to include enhanced obligations to protect labor rights and to address breaches of those obligations. On May 10, 2007, Congressional Democrats and leading officials in the Bush Administration reached agreement on a set of labor rights provisions that were inserted in U.S. FTAs with Peru, Colombia, Panama and South Korea. The Democratic Senator from Montana, Max Baucus, who is also Chairman of the Senate Finance Committee and known to be an influential force on international trade issues, reportedly would like to see the labor rights provisions from what is now known as the “May 10 agreement” carried forward in future U.S. BITs, including the 2010 Model BIT. A July 2009 report to Senator Baucus from the U.S. Government Accountability Office criticized the inadequate efforts, primarily of prior U.S. administrations, to ensure that governments with whom the U.S. had negotiated FTAs (specifically, Jordan, Morocco, Singapore and Chile) were making significant progress toward adoption and enforcement of fair labor laws. Thus, the interagency review of the 2010 Model BIT provides an opportunity to raise standards and expectations.

        Labor interests have exerted their influence inside the Office of the U.S. Trade Representative as the Administration has been developing its trade policy. Although the President’s promotion of exports in his State of the Union Address indicated a desire to expand trade, there remains in the Democratic Party suspicion of trade as a vehicle to export jobs as well as goods and services. Inclusion of apparently enforceable labor standards in international agreements would provide some cover against allegations that, were jobs exported, at least they would not be exported to foreigners working under substandard conditions.

         The Obama Administration has filled its ranks – in the White House and in several agencies – with officials who have strong views on protections for workers. Given the President’s and Democratic Party’s dependence on labor interests for their political base (a political reality China already has experienced in the application of the Section 421 safeguard over commercial tires), labor rights are likely to play an important role in the negotiation of a BIT with China, as well as any other BITs or FTAs negotiated during the Obama Administration.

         The “May 10 agreement” labor provisions that could be included in the 2010 Model BIT adopt the rights expressed in the 1998 ILO Declaration on Fundamental Principles and Rights at Work:

(a) freedom of association and the effective recognition of the right to collective bargaining;

(b) the elimination of all forms of forced or compulsory labor;

(c) the effective abolition of child labor; and

(d) the elimination of discrimination in respect of employment and occupation.

          Recent U.S.-FTAs incorporate these rights as mutual, reciprocal obligations undertaken by the FTA partners. Parties must agree not to waive or otherwise derogate from statutes implementing these international standards in a manner affecting trade or investment between the parties, and they must commit to effectively enforce their labor laws. They must ensure access to tribunals to enforce labor laws and procedural guarantees of transparency and due process.

          The agreements provide dispute resolution procedures in the event that these rights are not believed to be respected and enforced by the FTA partner. The process, however, is fashioned to blunt attacks on foreign labor practices. In the Korea-U.S. FTA, for example, the dispute process over labor rights is potentially lengthy, with multiple stages of consultation between the governments before an arbitral panel eventually is formed to adjudicate and the awards are not self-executing. Although the dispute settlement process does allow for compensation and sanctions as potential remedies for a party’s failure to implement an award, there are abundant opportunities for international diplomacy and negotiation to avoid an outcome requiring strict enforcement. The dispute settlement framework seems designed to cushion the effects of a violation of the labor obligations, and to allow governments opportunities to save face in the event of an alleged breach.

          Were the 2010 Model BIT to go beyond the text of recent FTAs by establishing well-defined labor standards with strict and efficient dispute settlement mechanisms, accession to such a BIT with the U.S. could be problematic for China. The All-China Federation of Trade Unions is the only legally authorized union in China, and critics claim that it is more interested in preserving stability for the government than it is in protecting workers’ rights. U.S. labor organizations have argued that even where China has the appropriate labor laws on its books, enforcement of those laws consistent with international standards remains unreliable. The Obama Administration has heard from some in the United States that China never will agree to the adoption and enforcement of international labor standards and reportedly is weighing those views carefully.

         A dispute-settlement model based on the Korea-U.S. FTA, however, might be palatable if China were to see in it sufficient flexibility for negotiation, diplomacy, and the ability to preserve a public face of sovereignty with respect to its labor laws. The United States currently appears to be making serious progress on BIT negotiations with China’s competitors, India and Vietnam. Were these countries to move more rapidly to agreement on the inclusion of meaningful protections for labor rights, competition and comparative advantage may create additional incentives for China to accept such provisions in a BIT with the United States. China might then hope to mitigate their impact, whether through the kind of consultation processes suggested in the Korea-U.S. FTA, or by maintaining the appearances of a commitment to enforcement as circumstances may require.
 

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Despite the joint announcement of the United States and China that both countries would “expedite negotiation on a bilateral investment treaty” (abbreviated in English as a “BIT”), the notion of a BIT between the United States and China, two of the world’s five largest economies, remains inconceivable for some. On the U.S. side, there are significant political obstacles: free trade and foreign investment typically are not successful campaign platforms for U.S. politicians during an economic recession, especially in an election year. U.S. politicians would not likely accept a BIT while strong disagreement remains over China’s currency policies. China’s pegging of the yuan to the dollar remains an irritant (indeed, the only trade issue on President Obama’s agenda in Beijing in November), notwithstanding that it may have enabled critical flows of debt-financing while the United States endured the depths of a recession while still needing billions for military actions in Iraq and Afghanistan. There are obstacles on Chinese protection and enforcement of U.S. intellectual property, controlled Chinese capital markets, and laws raising national treatment concerns for American investors trying to establish investments in China, according to Amy Tsui’s BNA Int’l Trade Daily article.  Political support for a BIT with China does not look promising, particularly with a Congress whose Democratic leadership is often openly suspicious of Chinese trade and investment intentions.

China has its own policy disagreements with the United States, including on trade issues such as the United States’ safeguard duties on Chinese tires. China also has been reluctant to embrace international arbitration of investor-state investment disputes to the degree that the United States would demand using the 2004 U.S. Model BIT as the basis for negotiations.

Notwithstanding these obstacles, there are reasons to believe that a U.S.-China BIT is not a question of “whether” but “when.” When the Bush Administration announced in June 2008 that the United States and China had been discussing a BIT as part of the Strategic Economic Dialogue, at least one observer wondered whether the announcement meant a deal had been completed. According to a U.S. official, talks of a U.S.-China BIT already had been going on for seventeen months. Under the Obama Administration, it appears that discussions are continuing “in technical stages [but] have not yet reached political decisions.” (“ACIEP Report on Model BIT Lacks Consensus on Critical Issues,” Inside U.S. Trade, Oct. 2, 2009.)

BITs are smaller in scope than free trade agreements (“FTAs”). The negotiations, therefore, are much more attainable, in terms of both the substance and the political capital expended to reach an agreement. BITs tend to favor the country in the agreement that is the larger exporter of capital, which usually has meant that the United States stood to benefit far more than its treaty partner. Of the approximately 60 countries with whom the United States previously has agreed on BITs or FTA investment chapters, Canada and South Korea are the only significant exporters of capital.

U.S. businesses see BITs as a way to open up access to foreign markets, and China would be no exception. For many years, U.S. industries have been looking for ways to improve access to China’s one billion consumers and to eliminate restrictions on or disincentives to foreign investment, particularly as, during recent years of high economic growth, the Chinese have accumulated unprecedented wealth for a developing country.

China, unlike most of the United States’ treaty partners in prior BITs, has become a significant exporter of capital, but this fact probably makes a BIT even more likely. Since 1998, China has been renegotiating BITs it had with many European countries in order to provide greater protection for its own investors doing business in Europe. Recently, China also has been in BIT negotiations with Canada. As China increases its investments in the United States, it becomes increasingly likely that China will want the same protections for its investors doing business there.

There have been critics in the United States fearing that BIT provisions for international investor-state arbitration circumvent U.S. judicial, legislative and regulatory processes, and many certainly would oppose a BIT with China given the implications for U.S. environmental and labor standards. And yet, there is little reason for anyone to believe that the United States would be overrun with foreign claims under a U.S.-China BIT. Notwithstanding Canada’s significant investments in the United States market, in the sixteen-year period since the adoption of NAFTA’s investment chapter no arbitration tribunal has required the United States to pay on a single claim.

Political concerns over U.S. national security restrictions on investment have subsided since 2005 when CNOOC’s bid to purchase UNOCAL was blocked, as discussed in our previous post in December. Specific transactions still may be blocked, but those decisions appear to be driven more by the national security analysis of a particular case than by reactionary measures to calm an agitated Congress, as discussed in our earlier post in January.

U.S. industry representatives have recommended that the United States should consider softening the “essential security” exception in its Model BIT language to allow foreign investors greater assurances that their investments will not be disrupted by disguised protectionist motivations.  (“ACIEP Report on Model BIT Lacks Consensus on Critical Issues,” Inside U.S. Trade, Oct. 2, 2009.)  While they plainly intend for the exception to be softened as to foreign countries’ restrictions on foreign U.S. investment, the reciprocal nature of such a provision would be appealing to the Chinese as well. There may not be enough sympathy in Congress, however, for such a departure.

Negotiation of a China-U.S. BIT will not be quick and easy, but it remains likely. China is an expanding market attracting foreign investment from around the globe. American enterprises want to invest there and would like more security for their investments. Such incentives historically have driven the United States to negotiate BITs.

This time, however, there is an added and critical dimension. China has amassed capital and is beginning to invest abroad. The United States not only is an attractive market; the United States also needs a substantial share of that investment for the growth of its own economy. Chinese businessmen, like Americans, want investment security. This time, therefore, the BIT partners share a common vision of an agreement that will attract investment to their own countries while protecting their citizens investing abroad. Such unusual balance may make the negotiations more difficult, but they also make a positive result more likely.
 

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This blog posted an article titled “Setting The Record Straight: The U.S. Is Open For Chinese Business; Don't Worry Too Much About National Security Reviews” on December 12, 2009. Two weeks later Northwest Non Ferrous International Investment Co., Ltd. (“Northwest”) dropped its plans to acquire a Nevada mining company because a national security review under the Foreign Investment National Security Act “FINSA” was coming to an unfavorable conclusion. We do not stand corrected.

The rejection of the Northwest acquisition was based on unique facts and not because of opposition to Chinese investment generally. Chinese companies should not let this case dissuade them from acquiring companies and otherwise investing in the United States.

Northwest proposed to acquire control over a mining company, Firstgold Corp., all of whose operations are adjacent to Naval Air Station Fallon, the U.S. Navy’s premier tactical air warfare training center. The Navy opposed a company owned by the Chinese Government having control of property from which its most sensitive training activities might be monitored. Also in that area are other security and military assets so sensitive that the U.S. Government treats even their identities as classified information.

Due to the sensitive nature of the government installations, any acquisition by a foreign company, including companies based in NATO countries, would have raised national security concerns. Whether China created more concern is entirely speculative and ultimately unknowable. However, Chinese companies should not view the CFIUS result in this case as based on an objection focused on China, but rather as based on the serious national security concerns it definitely presented regardless of the foreign country. FINSA requires CFIUS to consider whether the acquiring company is state-owned. However, given the serious national security concerns raised by the location of Firstgold’s facilities, the result likely would have been the same even had the acquirer been a private company.

Northwest’s lawyers have described extraordinary but failed efforts to make the acquisition compatible with national security concerns. Their memorandum to Northwest, published on the New York Times website, reports that the Committee on Foreign Investment in the United States (“CFIUS”) looked closely at all kinds of scenarios to mitigate the national security concerns, but concluded that none of them would be feasible because all four of Firstgold’s properties are located adjacent to Naval Air Station Fallon or other military sensitive locations.

The lawyers’ report demonstrates that CFIUS’ goal is not to block investments. Instead, CFIUS seeks to mitigate national security concerns. The exceptional facts in this case are that all of the operations to be acquired raised concerns. When national security is at issue, it usually affects some part of the deal and can be mitigated. Here, all of the deal was implicated; mitigation (such as spinning off some part of the deal while preserving the essential economic value) apparently was impossible.

Northwest acted wisely in this case, seeking a CFIUS review before investing because of uncertainties about national security. Reportedly, Firstgold did not want to request CFIUS review. Northwest could have invested, only to have CFIUS recommend and the President of the United States undo the deal, not because of animus toward Chinese investment, but because of the serious implications for national security.

It is important not to misinterpret the Northwest case. It proves the utility and wisdom of early CFIUS review, not an objection to Chinese investment. Notwithstanding CFIUS’ rejection of Northwest’s proposed acquisition of Firstgold, the United States remains one of the economies most open in the world to foreign investment, including from China.
 

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Chinese and other foreign companies considering investments in the United States often are confused about the degree to which the United States is open to foreign investment. They hear terms such as CFIUS, Exon-Florio and FINSA and claims that the United States is now hostile to foreign investment, especially from China and the Middle East.

The reality is that the United States remains one of the economies most open in the world to foreign investment. When it comes to greenfield investments creating new businesses in the United States, foreigners are as free to invest as domestic concerns. The United States does have procedures for reviewing foreign acquisitions of existing businesses under the Foreign Investment National Security Act of 2007 (“FINSA”), conducted by the inter-agency Committee on Foreign Investment in the United States (“CFIUS”), presided over by the U.S. Treasury Department. However, as the Treasury Department noted when it published its CFIUS guidance, “CFIUS focuses solely on any genuine national security concerns raised by a covered transaction, not on other national interests.”

Notwithstanding today’s difficult economic climate and the confusion over national security reviews of foreign investment, Chinese companies obviously remain interested in acquiring U.S. companies. For example, on October 23, 2009 BGP Inc., a subsidiary of China National Petroleum Corporation, agreed to a joint venture with ION Geophysical Corporation, a Houston, Texas based company specializing in seismic products used in oil and gas exploration. According to ION’s press release, the transaction, which would result in the Chinese company owning 16.66% of ION, is contingent upon obtaining clearance of the transaction from CFIUS. This proposed acquisition is likely to face an exhaustive and extended CFIUS review because it is in a particularly sensitive sector, energy, and the ultimate acquirer is a Chinese state-owned enterprise. Although CFIUS may require some conditions designed to mitigate national security concerns, the transaction probably will be approved.

Congress passed FINSA in 2007 following controversies over the China National Offshore Oil Corporation’s attempted acquisition in 2005 of Unocal, a U.S. energy company, and Dubai Ports World’s acquisition in 2006 of a British company that managed several major seaports in the United States. These controversies focused congressional attention on CFIUS; the earlier Exon-Florio procedures for review of foreign acquisitions; potential harm to U.S. national security that could arise from foreign control of energy, infrastructure and critical technologies; and on investments by state-owned entities. The public debate over these cases and a new law, however, was not one-sided and the Administration convinced Congress to balance national security concerns with the need for the United States to remain open to foreign investment. FINSA, legislated on July 26, 2007, is not a barrier to foreign investment, but a balance of investment with national security.

FINSA covers any transaction that “could result in control of a U.S. business by a foreign person.” It covers transactions that could result in the switch of control from one foreign person to another. However, it does not cover greenfield investments or a strictly real estate transaction. Control over an existing U.S. business must be at stake. “Control” is defined very broadly. Thus, even the acquisition of a relatively small minority stake in a company could be covered by FINSA.

FINSA does not pose a significant barrier to the vast majority of foreign acquisitions of U.S. businesses because, although all such acquisitions are covered transactions, the President’s authority under FINSA to suspend or prohibit a covered transaction can be exercised only when the President finds that “the foreign interest exercising control might take action that threatens to impair the national security.” Neither the statute, nor its implementing regulations, defines “national security” and Congress intended CFIUS to interpret that term broadly to include, among other things, energy, critical materials, critical technologies, homeland security and infrastructure. Nonetheless, where there is no plausible connection between the business conducted by the U.S. company to be acquired and national security, FINSA will not be an issue.

Whenever a transaction covered by FINSA might affect national security, FINSA provides a review process whereby the parties to the transaction can seek clearance from CFIUS before they have invested a great deal. A CFIUS review is not mandatory, but companies generally seek one whenever there is a possibility that the transaction could be considered to affect national security. Once a transaction has been cleared by CFIUS, it cannot subsequently be challenged under FINSA unless one of the parties to the transaction submits false or misleading material information.

Companies take advantage of the CFIUS safe harbor – the preclearance -- by submitting a voluntary notice of a proposed transaction providing the detailed and extensive information that CFIUS’ regulations require for such notices. The filing of the notice commences a 30 day initial review process. Most transactions are cleared within this initial 30 day period.

When any of the CFIUS member agencies have unresolved national security concerns with a proposed transaction, a formal 45 day investigation begins. The parties typically resolve transactions that go through this second stage by agreeing with the government to mitigate the agencies’ national security concerns.

Mitigation agreements can involve modifications to the transaction, certain limitations on the new foreign owner’s exercise of control, or extra protections for critical technologies or facilities. A very small number of transactions pose national security concerns that cannot be mitigated successfully. Those transactions usually are abandoned before the completion of the CFIUS process. It is rare for CFIUS to complete its review with a recommendation to the President that a transaction be blocked.

The United States remains committed to an open investment environment, treating foreign investors on an equal footing with their domestic competition. It was for this reason that Congress set the initial CFIUS review deadline at 30 days, to coincide with the 30 day antitrust review period for mergers and acquisitions. The expanded view of national security mandated by FINSA does mean that CFIUS national security reviews are a crucial part of transactions involving foreign investment, but it is no more onerous than an antitrust examination.

Most important for success in a CFIUS review is understanding in advance the concerns of CFIUS member agencies, creative thinking about how to demonstrate that those concerns are not threatened, and where perceived threat may be reasonable, creative proposal to mitigate them. In most cases early attention to the CFIUS process and to the legitimate concerns of the member agencies, Congress, and the public, can ensure smooth and timely proceedings that result in CFIUS clearance without restrictions, or on terms that preserve the value of the transaction for all parties.

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