The United Mexican States (“Mexico”) appealed the decision of the Ontario Superior Court of Justice upholding an award by a NAFTA arbitration tribunal which had found that Mexico had engaged in discriminatory conduct by granting tax rebates to domestic companies that were denied to a company engaged in a similar business owned by a U.S. citizen (“Karpa”). The Ontario Court of Appeal dismissed the appeal and held that the arbitration tribunal was entitled to a high degree of deference and Mexico had not shown any basis upon which to interfere with the arbitration award.

Administrative law – Arbitration and award – Decisions of administrative tribunals – Arbitration Board – NAFTA – Tax rebates – Companies – Less favourable treatment – Discrimination – Judicial review – Procedural requirements and fairness – Disclosure

United Mexican States v. Karpa, [2005] O.J. No. 16, Ontario Court of Appeal, January 11, 2005, D.H. Doherty, R.P. Armstrong and S.E. Lang JJ.A.

Karpa was a citizen of the United States who operated an export business in Mexico which purchased cigarettes from volume retailers and sold them to purchasers outside Mexico. Cigarettes exported from Mexico qualify for a rebate of the Special Tax on Production and Services (“IEPS”). In order to obtain the rebate, the exporter must provide invoices that “separately and expressly state the amount of the IEPS tax paid”. Karpa’s export company (“CEMSA”) applied for the tax rebates and, from time to time, such rebates were granted. Subsequently, Mexico changed its approach and CEMSA was denied the tax rebates because it was unable to produce invoices that separately stated the amount of tax paid. In 1998, the Mexican taxation agency performed an audit of CEMSA which concluded that CEMSA had received IEPS tax rebates between January 1996 and September 1997. The taxation agency claimed repayment of approximately US $25 million.

On April 30, 1999, Karpa referred these matters to arbitration by filing a notice of arbitration pursuant to chapter 11, article 1120, of the North American Free Trade Agreement (“NAFTA”). A tribunal was established to hear the arbitration. Karpa sought damages equivalent to US $50 million. Karpa based his claim on three grounds, including an allegation that Mexico had breached Article 1102 of NAFTA which required Mexico to accord to investors of another party to NAFTA treatment no less favourable than it accorded to its own investors.

Karpa sought to prove his case through the production of records from the Mexican taxing authority in respect of its treatment of domestic taxpayers. Mexico refused to produce such records. The majority of the arbitration panel found there had been a breach of Article 1102 by Mexico and that Karpa had made a prima facie case for differential and less favourable treatment compared with local Mexican companies engaged in the same business. The tribunal calculated damages on the basis of rebates withheld from CEMSA and awarded approximately US $1.6 million.

Mexico appealed the tribunal decision to the Ontario Superior Court of Justice. The Ontario courts had jurisdiction because Ottawa was named as place of arbitration, although the hearing took place in Washington, D.C. In the Superior Court of Justice, Mexico proceeded under the International Commercial Arbitration Act, R.S.O. 1990, c. I-9 and the UNICITRAL Model Law on International Commercial Arbitration, which is attached as a schedule to the Act. Mexico attacked the award of the arbitration panel, alleging that the procedure adopted by the tribunal was contrary to the agreement of the parties. Mexico also argued that it was unable to present its case by reason of the majority of the tribunal drawing impermissible inferences from the evidence concerning Mexico’s treatment of Mexican businesses. The application judge refused to give effect to any of the grounds raised by Mexico and dismissed the application. Mexico appealed this decision to the Court of Appeal.

The Court of Appeal held that notions of international comity and the reality of the global marketplace militated in favour of the courts using their authority to interfere with international commercial arbitration awards sparingly. The court held that the applicable standard of review in this case was at the high end of the spectrum of judicial deference.

The Court of Appeal found that the critical issue in the case involved the inferences drawn by the tribunal where Mexico failed to provide any evidence of its tax treatment of Mexican investors. Mexico had argued that its own tax laws prevented disclosure of such information. It did, however, produce certain taxpayer information at the hearing. The Court of Appeal noted that the information produced by Mexico failed to satisfy the tribunal which, in turn, led the tribunal to conclude that if Mexico had evidence that a domestic taxpayer had been treated in a manner equivalent to CEMSA, it would have provided such evidence. The Court of Appeal held that the tribunal was entitled to come to such a conclusion.

The Court of Appeal rejected Mexico’s arguments that an award of damages was contrary to public policy. The court stated that the damages were equivalent to the rebates that CEMSA had been refused at the same time that domestic exporters were receiving rebates. The court found nothing fundamentally unjust or unfair about such an award and noted that the award was rationally connected to the discriminatory conduct found by the tribunal.

In the result, Mexico’s appeal was dismissed.

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