NAFTA Effects

U.S. contracts could be voided by free-trade agreements, as a case involving Loewen Group shows.
Nikos ValanceMarch 1, 2000

The violent protests surrounding the World Trade Organization (WTO) meeting in Seattle last November created headlines, but a quieter battle elsewhere over the rules of international trade may have more immediate implications for U.S. companies.

The case of Loewen v. O’Keefe pit Loewen Group, a Canadian operator of funeral homes, against O’Keefe, a funeral-home operator based in Biloxi, Mississippi. In the initial case, a Mississippi jury found against Loewen, awarding O’Keefe substantial damages. Now, four years later, Loewen is using the North American Free Trade Agreement (Nafta) statutes to countersue–not O’Keefe, but the U.S. government.

Much more than Loewen’s fate hangs in the balance. A decision in favor of the company, some experts say, could call into question the U.S. legal system’s capacity to withstand challenges from international organizations like the WTO. In this view, Nafta arbitration panels become an alternative forum for big-money cases in which American law or court procedures tend to favor an American plaintiff or defendant.

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“Corporations that can be chartered outside the country will be at a competitive advantage over those that can’t,” observes Robert Stumberg, a professor of law at Georgetown University.

The Loewen story began 10 years ago, when the funeral-home chain first entered the Mississippi market as part of an acquisition binge that saw the company grow from a single Manitoba mortuary in 1967 to more than 1,100 funeral parlors in the United States, Canada, and Great Britain. Through the acquisition of the Riemann funeral business in Gulfport, Mississippi; and of Wright & Ferguson, the largest funeral home in the state capital of Jackson, in 1990, Loewen began doing business with Jeremiah O’Keefe, a World War II hero, former state legislator, and mayor of Biloxi.

O’Keefe owned eight funeral parlors of his own and a funeral insurance business in Mississippi. He also had a multiyear, exclusive contract to sell burial insurance for Wright & Ferguson. But after Loewen acquired the company, O’Keefe claimed, Loewen refused to honor that contract and began selling its own insurance. When O’Keefe protested, Ray Loewen, the Canadian company’s founder and chairman, invited him to a meeting at his headquarters in Vancouver, and wined and dined O’Keefe as they ironed out their differences.

Double Indemnity

O’Keefe thought Loewen had agreed to stop selling insurance for the Jackson funeral home. But on his return to Mississippi, he found that Loewen was still doing so through a company owned by Riemann. When O’Keefe complained again, negotiations with Loewen produced a deal calling for O’Keefe to sell three of his funeral parlors to Loewen in return for exclusive rights to sell funeral insurance for Loewen for a minimum of two and a half years.

O’Keefe signed the agreement and Loewen’s board gave preliminary approval. Then Loewen immediately reneged on the deal, according to O’Keefe’s lawyers. While more meetings were held, O’Keefe’s business floundered. He soon found himself hard-pressed for the cash required by state insurance regulators to back a recent investment. With regulators breathing down O’Keefe’s neck, his company was eventually placed under administrative supervision. Bankruptcy loomed.

According to Michael Allred, O’Keefe’s lead lawyer, this had been Loewen’s plan all along. While negotiating the deal with O’Keefe, says Allred, Loewen held a secret meeting with Riemann, in which he told Riemann that he would not honor his agreement with O’Keefe. The idea, according to Allred, was to force local competitors like O’Keefe out of business, buy up the pieces, then price-gouge the market.

O’Keefe took Loewen to court in September 1995, and won a guilty verdict and damages against Loewen totaling $260 million, far in excess of the original $105 million requested by O’Keefe’s lawyers. But when the jury was instructed to decide punitive damages, the jury informed the judge that they had included those damages in the $260 million, so Loewen’s lawyers filed for a mistrial.

The judge denied the mistrial, but allowed the damages to stand without further deliberation if both parties agreed. Loewen’s lawyers refused. The jury returned a new verdict of $400 million in punitive damages, yielding a total in excess of half a billion dollars.

Funeral March

Ultimately, the amount rose even higher. Under Mississippi law, a bond of 125 percent has to be posted against damages in civil cases to ensure that assets aren’t hidden during the appeals process as a means of lowering potential damages. In Loewen’s case, the bond came to $625 million. The company immediately appealed to the Mississippi Supreme Court, but it ruled the company had to pay the bond in full.

Loewen survived the suit by O’Keefe, eventually settling with him for $50 million in cash, a million shares of Loewen stock, and a $200 million note, payable over 20 years. The company’s stock, after plunging below the teens at the time of the settlement, climbed back to a 52-week high of $42 in the third quarter of 1996.

But the company’s growth slowed, while its balance sheet remained highly leveraged. Two years after the verdict, Loewen reported a loss of almost $600 million for 1998. In October 1998, Ray Loewen resigned as president and CEO. And in June of last year, the company filed for bankruptcy, with its shares trading for 53 cents on the New York Stock Exchange.

The Loewen case would be just another corporate failure if that were the end of it. But while the company was heading down the tubes in the third quarter of 1998, Loewen decided to take the U.S. government to court for $725 million. It did so by filing suit with the International Center for the Settlement of Investment Disputes, based in Washington, D.C., one of two tribunals where claims can be filed under Nafta.

Under Chapter 11 of the trade agreement signed by Canada, Mexico, and the United States, and implemented in January 1994, each country must provide foreign corporations with a minimum standard of treatment, protections against expropriation of assets, guarantees of nondiscrimination, and protections against deprivation of use.

That sounds reasonable enough. But in what experts say is a remarkable departure from legal norms, Nafta allows foreign companies to sue governments over violations of these rights–as opposed to governments suing others on behalf of companies or individuals–through a binding resolution process. The process involves arbitration before a dispute-resolution panel composed of three experts selected on a case-by-case basis.

In Loewen’s case, the company claims that the Mississippi Supreme Court violated its rights under Chapter 11 of Nafta by imposing a 125 percent bond requirement, though the requirement is also on the books in 20 other states, arguing that it effectively expropriated the company’s assets. Loewen also claims that the Court denied it justice by not exempting it from the state law requirement, and that because the jury award was not proportional to the amount sought by the plaintiff, the jury demonstrated “anti-Canadian bias.”

Some observers dismiss Loewen’s Nafta case as ludicrous. “The fact that Loewen decided to sue three years after the jury verdict, when it was overleveraged and in a liquidity crisis, is suspicious, to say the least,” says Michelle Sforza, former research director of the Global Trade Watch program at Public Citizen, a consumer advocacy group founded by Ralph Nader.

If the Nafta tribunal disagrees, however, Sforza says U.S. companies would have reason to fear the precedent it would set. “First, they will have to obey American laws, while foreign companies will not,” she says. “Second, by claiming that they were unfairly treated by a jury in a civil case, they [would be] effectively claiming that the tort system of justice is an unfair trade practice that can’t be applied to foreign corporations.”

Sforza isn’t alone in voicing such concerns. As Stumberg of Georgetown contends: “Nafta’s Chapter 11 is tantamount to a constitutional amendment. It empowers foreign corporations to exact a price for the exercise of traditional government authority, which shifts power away from states and provinces.”

While a Canadian, an American, and an Australian have been impaneled to hear the Loewen case, a hearing date has not yet been set. Stumberg says that the Canadians have asked for a reinterpretation of the agreement. The United States has agreed, but Mexico has not.

Two-Way Street

Why did Nafta’s U.S. negotiators fail to anticipate the problems? “The U.S. argued strongly for this in the negotiations because of cases it wanted to bring against Mexico,” says John H. Jackson, another Georgetown law professor who served as general counsel to the U.S. Trade Representative’s Office in the 1970s. “It’s ironic that a case is now coming against the U.S.,” Jackson adds.

Loewen isn’t the only example of a company suing a government under Nafta, and some of the others show that the recourse provided by the agreement can be a two-way street. For instance, in July 1998, Ethyl Corp., a Virginia-based chemical company, got the government of Canada to remove a ban on the importation and interprovincial transport of MMT, a gasoline additive made by Ethyl, after threatening to sue the Canadian Parliament under Nafta.

Of course, it’s always possible that the Nafta tribunals will rule against Loewen and the other companies. “Nafta guarantees a trial, but it doesn’t guarantee a verdict,” notes Barry Appleton, a Toronto-based lawyer specializing in international trade law, who represented Ethyl in its case against the Canadian government.

Appleton, for one, dismisses concerns that the agreement, in effect, overturns the U.S. system of tort law and amounts to a constitutional amendment. “Those claims are ludicrous,” says Appleton. “Nafta doesn’t strike down laws; it awards damages.”

Maybe so. Yet Georgetown’s Jackson predicts that U.S. negotiators from now on will seek to rein in the ability of foreign companies to exploit trade rules in this fashion. “The U.S. will be a lot more cautious in drafting investor- state treaties in the future than it was in the past,” Jackson contends.

All of which is small comfort for companies in Jeremiah O’Keefe’s position.


Legal critics of the arbitration process established under Nafta cite the following aspects as cause for concern:

The panels meet behind closed doors, and the proceedings need not be made public.
Friends-of-the- court briefs are accepted only at the discretion of the panel.
Decisions cannot be appealed.
The panels needn’t follow U.S. laws or the precedents they set, or refer to them for guidance.
The panels are reconstituted for each dispute and aren’t required to rely on precedents set by their precursors.

Source: Public Citizen