decision

Koch Industries, Inc. and Koch Supply & Trading, LP - decision

Litigation

Sabin

Sabin Litigation

Filing Year For Action

In 2016, Ontario, a province in Canada, established a cap-and-trade program for carbon emissions as part of the Western Climate Initiative (WCI), a collaborative effort among regional governments in the United States and Canada to create a shared emissions trading market. During auctions held in 2017 and 2018, KS&T acquired a significant number of emissions trading allowances, transferring the majority of these allowances to California, another participant in the WCI. While the specific value of the allowances is not disclosed in the arbitration award, earlier reports estimate the amount to be approximately USD 30 million, aligning with the claimants' stated damages in the arbitration.

In June 2018, a conservative government came to power in Ontario, announcing plans to terminate the cap-and-trade program. This decision included canceling a scheduled auction for additional emissions allowances that month. Subsequently, California ceased recognizing Ontario's emissions allowances, preventing KS&T from transferring certain recently purchased allowances out of Ontario. By October 2018, Ontario formally ended the cap-and-trade program, invalidating existing emissions allowances without providing any compensation to "market participants," including those who had purchased allowances on the secondary market.

In December 2020, Koch Industries and KS&T initiated an ICSID arbitration, challenging Ontario's cancellation of their emissions trading allowances under NAFTA. They relied on the “Legacy Investments” provision of the USMCA, as previously discussed in detail.

As the Tribunal declined jurisdiction, it did not consider the merits issues. However, it did clarify several issues on international carbon trading emissions which are crucial for the intersection of ISDS and climate change moving forward. We summarize those issues below: 

Whether the emission allowances held by the investor constituted property in Ontario under Article 1139(g) of NAFTA.
Canada argued that the investor´s emissions trading allowances did not qualify as protected investments under NAFTA. The claimants, however, argued that the allowances constituted “property” under NAFTA Article 1139(g), asserting that the term “property” carried an independent and expansive meaning under customary international law. In response, Canada maintained that the allowances lacked essential common-law characteristics of property and that the cap-and-trade program did not demonstrate any intention to create proprietary rights in emissions trading allowances. Citing Lion v. Mexico, the tribunal held that the claimants needed to “prove that the asset over which the claimant alleges property rights is considered as property in that legal system, and that, according to the corresponding laws or rules of that legal system, the property right is vested in the claimant.”

The tribunal noted that the cap-and-trade program did not define emissions allowances as property rights and examined whether the allowances met the Ontario common-law definition of property. The tribunal reviewed several Canadian court rulings addressing claims to novel intangible property rights. Ultimately, it found no decision that established a general test for determining the existence of property. Specifically, the tribunal considered: (i) the Saulnier case, (ii) the Anglehart case, (iii) the Tucows case, (iv) the Bouckhuyt case. Synthesizing principles from these cases, the tribunal determined, among others that:
•        Significant government discretion in deciding what constitutes property may negate the exclusivity necessary to establish property rights.
•        Predictability of renewal of emissions trading’s allowances has limited relevance.
•        Government powers to take, modify, or remove statutory rights without compensation, or to exclude expropriation claims, may indicate a lack of “exclusive control” and, therefore, a lack of property rights.

The Tribunal ultimately concluded that emissions allowances are not property within are not “property” within the meaning of NAFTA Article 1139(g). The Tribunal’s analysis centered on whether emission allowances under Ontario’s Cap and Trade Act satisfied the “exclusive control” element necessary to constitute property under Ontario law. While the claimants argued that provisions in the Act allowed participants exclusive rights to trade, hold, and use allowances, the Tribunal noted that these provisions were subject to significant government oversight and restrictions. For instance, the government retained broad discretionary powers to regulate allowances, including canceling them, imposing conditions, and limiting their transferability. These powers, alongside statutory limitations on compensation and expropriation claims under Section 70, indicated that the government maintained overarching control over the allowances, undermining the claimants’ assertion of exclusive control. The Tribunal found that this regulatory framework was inconsistent with the degree of autonomy typically required for property under Ontario law.

The Tribunal also evaluated Canadian case law, which emphasized exclusivity as the defining characteristic of property. Cases such as Bouckhuyt and Saulnier highlighted that property rights require a significant degree of autonomy and exclusivity, which were lacking in this instance due to the government’s regulatory powers. Although the Tribunal acknowledged that emission allowances exhibited some attributes of property, it ultimately concluded that the claimants failed to demonstrate sufficient control to satisfy the exclusivity element. Therefore, the Tribunal found that the emission allowances did not constitute property under Ontario law and, consequently, did not qualify as an investment under Article 1139(g) of NAFTA. This decision underscores the challenges of asserting property rights in regulatory frameworks designed to address climate and environmental objectives.

Whether cross-border emission trading activities are classified as an economic activity under Article 1139(h).

The claimants sought to characterize the emissions allowances and their trading business as “interests arising from the commitment of capital or other resources in the territory of a Party to economic activity in such territory,” within the meaning of NAFTA Article 1139(h). In contrast, the respondent contended that respondents’ interests did not meet the requirements of Article 1139(h) and failed to align with the illustrative examples provided in the provision, which emphasize contracts involving property or economic activity directly tied to the host state. Notably, the Tribunal emphasized that the claimants needed to show “a cognizable interest that results from committing those resources within the territory of a Party towards economic activity within that territory,” meaning economic activity in Ontario specifically.

The tribunal further held that the claimant’s emissions allowances did not provide it with a legal share in any asset or resource, and therefore, did not constitute a qualifying interest. Moreover, the Tribunal noted that the trading activities—purchasing allowances in auctions and reselling them in secondary markets—did not align with the types of interests described in the Article 1139(h) examples, as the Claimant did not operate an enterprise in Ontario. Additionally, the tribunal observed that the Claimant lacked any physical or corporate presence, or economic activity, in Ontario, apart from employing a local representative to satisfy regulatory obligations. Its trading operations were conducted entirely from the United States, and there was “no evidence that KS&T’s trading business was linked to a specific underlying economic project, operation, or activity taking place in Ontario.” As in Apotex v. USA and Canadian Cattlemen v. USA, the tribunal concluded that the Claimant’s cross-border trading activities through auctions and transfers of emissions allowances did not qualify as protected investments.

Conclusion 

On this basis, the Tribunal held that it lacked jurisdiction over the claims filed by Claimants, Koch Industries, Inc. and Koch Supply & Trading, LP, against Respondent, Canada, and that each Party shall bear its own costs, fees, and expenses.