Canadian Arbitration Blog

No property, no investment: Koch Industries’ carbon allowances not an ‘asset’ under NAFTA

Jun 10, 2024 7 MIN READ
Authors
Jacob A. Sadikman

Partner, Commercial, Toronto

Geoffrey Hunnisett

Partner, Disputes, Toronto

Clare Barrowman

Associate, Disputes, Toronto

Ainsley Leguard

Articling Student, Toronto

The International Centre for Settlement of Investment Disputes (ICSID) recently released its highly anticipated decision in Koch Industries, Inc. and Koch Supply & Trading, LP v. CanadaICSID Case No. ARB/20/52 [PDF], with a finding that the claimant, Koch, is not entitled to damages from Canada resulting from the cancelation of Ontario’s greenhouse gas emissions cap and trade program in 2018.

The central question before the tribunal was: did emission allowances under Ontario’s cap and trade program constitute property for the purpose of Article 1139(g) of the North American Free Trade Agreement (NAFTA)?

The tribunal considered whether carbon market investments like emission allowances constitute intangible property — a question not yet considered by Ontario courts. Canada, as respondent, was successful in its argument that because emissions allowances do not constitute property (among other reasons), the tribunal lacked jurisdiction to hear the claim.

Background to claim

On January 1, 2017, Ontario’s Cap and Trade program commenced under the Climate Change Mitigation and Low-Carbon Economy Act, and the Cap and Trade Program Regulation. Under the Ontario Cap and Trade program, “market participants” were permitted to engage in the business of buying and selling emission allowances — without being emitters themselves.[i]

Koch Industries registered an affiliate as a “market participant” under Ontario’s Cap and Trade program and began to purchase and trade in emission allowances.

On January 1, 2018, Ontario linked its Cap and Trade program with the programs in California and Québec. This cross-border linkage (known as the Western Climate Initiative) allowed for joint auctions of allowances, the transfer of emissions allowances between jurisdictions, and emissions allowance trading between the three jurisdictions.

When Doug Ford was elected premier of Ontario in June 2018, he announced that Ontario’s Cap and Trade program would be canceled. This announcement led California and Québec to de-link their programs from Ontario, preventing market participants from transferring emission allowances out of Ontario. On July 3, 2018, Ontario Regulation 386/18 came into force, which prohibited Ontario registered participants from purchasing, selling, trading or otherwise dealing in emission allowances and credits.

On October 31, 2018, the Cap and Trade Cancellation Act received royal assent. The Act provided that market participants would receive no compensation for unused emission allowances, rendering the emission allowances held by Koch Industries valueless, and also barred actions against the Crown arising from the cancellation of the Cap and Trade Program.

The claim

In February 2020, Koch brought a claim under Chapter 11 of NAFTA (which created a mechanism for investor-state dispute resolution) for more than US$30 million — representing amounts it spent purchasing emission allowances.

Koch argued that the ICSID had jurisdiction to hear the claim because the emission allowances were intangible property acquired for economic benefit or other business purposes under NAFTA Article 1139(g).

Canada submitted that ICSID lacked jurisdiction to hear the dispute as the emissions allowances did not qualify as an “investment” because the allowances are not property under Ontario law, as required by NAFTA Article 1139(g). Canada further argued that Koch did not hold “interests arising from the commitment of capital or other resources in the territory of a party to economic activity in such territory” under NAFTA Article 1139(h).

In the absence of any express definition of “property” in NAFTA, the parties’ agreed that the question of whether emission allowances constitute property “should be examined principally on the basis of Ontario law.”[ii] (In adjudicating the matter, the tribunal expressly stated that its analysis was only intended to be a determination of jurisdiction under Article 1139(g) of NAFTA,[iii] and not a general test or rule of interpretation under Ontario, Canadian or common law.[iv])

The tribunal’s decision

The tribunal determined that the emission allowances were not “property” under Ontario law. In reaching this conclusion, the tribunal surveyed Ontario law, international law, and analyzed the language of the Climate Change Mitigation and Low-Carbon Economy Act.

Analysis of Ontario law regarding the determination of property

The parties’ experts disagreed on whether there was a clear legal test for “property” established by Ontario law. The tribunal reviewed three appellate decisions dealing with the definition of property: Saulnier v. Royal Bank of Canada, 2008 SCC 58, Anglehart v. Canada, 2018 FCA 115 (Anglehart), Tucows.Com Co v. Lojas Renner SA, 2011 ONCA 548 (Tucows), and Re National Trust Co and Bouckhuyt et al, 1987 CanLII 4098 (ON CA) (Bouckhuyt), and determined that there is no general and settled test that can be derived from the jurisprudence.

However, the tribunal confirmed that “exclusive control”, enforceable against all others, is an essential attribute of property under Ontario law.[v] The tribunal further found that, while Ontario law does not clearly establish the scope and extent of rights required to satisfy exclusive control, if a statute grants discretionary powers to a governmental regulator that allow it to interfere with or appropriate the assets at issue, this may indicate that the assets do not qualify as property.[vi]

Analysis of international law regarding the determination of property

The tribunal considered Armstrong DLW GMBH v. Winnington Networks Ltd, [2012] EWHC 10(Ch) (Armstrong), in which the High Court of England and Wales determined the proprietary status of European Union (EU) allowances under the EU cap and trade scheme, which, like the Ontario Climate Change Mitigation and Low-Carbon Economy Act, does not define whether an emission allowance constitutes property. This decision included the following test for determining whether a right or interest constitutes property: the right or interest must (1) be definable (2) be identifiable by third parties (3) be capable of assumption by third parties, and (4) have a degree of permanence or stability.

The tribunal found that relevance of Armstrong was limited due to the disparate approaches to the creation of common law definitions of property by courts in the U.K. and Canada. Specifically, the tribunal noted that, in contrast to courts in the U.K., Canadian courts have been reluctant to create general rules or tests to define property. Rather, Canadian jurisprudence is highly fact and statute specific.[vii]

Further, the tribunal noted that international cases did not include the element of exclusive control, which is recognized to be a core element for the determination of property under Ontario common law.[viii]

Application to the statutory provisions at Iisue

The tribunal concluded that there were a significant number of provisions in the Cap and Trade Act which granted the regulator broad powers and thereby limited the exclusive control of emission allowance holders. Accordingly, the tribunal found that holders of emission allowances were not granted propriety rights, but only control over certain rights in limited circumstances.[ix]

The tribunal noted that this was “a very close case”, and the claimants were correct that the emission allowances have a number of the attributes of property under common law. However, the Act did not allow for exclusive control, which the tribunal found to be the key element in the determination of property.[x]

Other arguments on jurisdiction

The tribunal also denied Koch’s other arguments for jurisdiction, finding that the emission allowances did not constitute “interest” as outlined in Article 1139(h),[xi] and that Koch’s carbon trading business considered in the context of Article 1139(h) as a whole does not constitute protected investments because Koch’s activity was based on cross-border trade.[xii] 

The tribunal’s findings that Koch’s emission allowances were not property under Article 1139(g) — and not a qualifying investment under Article 1139(h) — precluded findings of jurisdiction under the claimant’s other proposed grounds.[xiii]

Key takeaways

While the tribunal’s determination of whether emission allowances constitute property is not binding on Canadian courts, its thorough analysis may still be instructive in predicting how courts will consider similar issues. In assessing the value of any carbon market investments, prudent investors should therefore consider the scope of discretion granted to a regulator in respect of those rights or interests, in conjunction with the drafting of commercial contracts for such products where defined terms such as “environmental attributes” are typically used to define a broad basket of inchoate property rights associated with specific environmental benefits or impacts. Considering the political risk inherent in any similar investment, and the potential protections (if any) afforded by international treaties and other agreements, is also critically important.

It is also possible that, as a result of the Koch arbitration and associated press coverage, legislators may elect — as California opted to do in its cap and trade legislation — to include explicit statutory language indicating that carbon market investments are not considered property.[xiv]

[i] Climate Change Mitigation and Low-Carbon Economy ActSO 2016, c 7s 17.

[ii] Koch Industries, Inc and Koch Supply & Trading, LP v. CanadaICSID Case No ARB/20/52 [PDF], at para. 159 [Koch v. Canada].

[iii] Although NAFTA has since been replaced with the U.S. Mexico Canada Agreement, the relevant provisions in this arbitration are substantially unchanged.

[iv] Koch v. Canada at para. 156.

[v] Ibid. at para. 240.

[vi] Ibid. at para. 292.

[vii] Koch v. Canada at paras 264–65.

[viii] Ibid. at para. 268.

[ix] Ibid. at para. 313.

[x] Ibid. at para. 316.

[xi] Ibid. at para. 356.

[xii] Ibid. at para. 366.

[xiii] Ibid. at para. 413.

[xiv] 17 CCR s. 95820(c).