FINAL REPORT OF THE PANEL UNDER CHAPTER 18 OF THE CANADA-UNITED STATES FREE TRADE AGREEMENT

3.44 In a letter dated July 9, 1992, the Canadian Minister of International Trade wrote:

3.45 On August 24, 1992, Acting United States Trade Representative (''Acting USTR'') Katz wrote to the Canadian Minister for International Trade presenting an FDA proposal for a three part equivalency study of the Québec/Canadian regulation and inspection system for UHT milk, which could be completed by January 1993. Acting USTR Katz wrote:

3.46 On September 16, 1992, the Canadian Minister for International Trade responded by rejecting the U.S. proposal. He wrote:

3.47 On September 17, 1992, the Canadian Minister for International Trade wrote to the United States Trade Representative requesting the establishment of a panel pursuant to Article 1807.2 FTA, and proposing a timetable and terms of reference.³⁹

3.48 On September 25, 1992, Acting USTR Katz wrote to the Canadian Minister of International Trade to clarify that the United States was not insisting that Canada or Québec implement an identical system to the PMO. Acting USTR Katz wrote that:

3.49 Acting USTR Katz's letter reiterated the offer of an equivalency study as an alternative to a Panel.⁴¹ On October 15, 1992, the Canadian Minister for International Trade responded by suggesting that an expedited six-week equivalency study be commenced. He proposed that the Panel timetable be modified to accommodate the equivalency process. He also requested assurances that if the study concluded that the two systems were substantially equivalent, the United States would ensure that all necessary measures be taken in order to give effect to those conclusions.⁴²

3.50 On November 9, 1992, the United States Trade Representative replied that it would be too costly and time-consuming to conduct an equivalency study and pursue a dispute settlement case simultaneously. With respect to assurances for full effect to be given to the results of such an equivalency study, she stated that the decision to reopen the Puerto Rico market to Québec UHT milk rested with the Government of Puerto Rico. However, she gave assurances that the United States would work with the NCIMS and Puerto Rico during the equivalency study to ensure that its conclusions were implemented.⁴³

4. Arguments Of The Parties

4.1 The United States and Canada agreed that the FTA applies to the Commonwealth of Puerto Rico.

4.2 The United States and Canada also agreed that the provisions of the FTA acknowledge the right of the Parties to adopt new technical standards. At the same time, the FTA provisions recognize the danger of governments raising new trade barriers under the guise of health or other technical standards.⁴⁴

(a) Submissions of Canada

4.3 Canada argued that the Puerto Rico licensing requirements governing the import, sale and distribution of milk (Department of Health Regulation 138 and Department of Agriculture Regulation 5) constituted a prohibition or quantitative limitation upon importation, breaching Article XI of the GATT which is incorporated into the FTA under Articles 407 and 710. It was submitted that the licensing requirements as they affected imports could be distinguished from their effects upon domestic sale and distribution. For imported milk, the license requirements would take effect before the product could enter the market.⁴⁵

4.4 Canada argued that import licenses are generally prohibited by GATT Article XI:1 unless their imposition is otherwise justified under exceptions appearing later in Article XI or elsewhere in the GATT. The Puerto Rico measures meet all of the criteria set out in GATT Article XI:I: (1) they operate to restrict completely the quantity of UHT milk from Québec entering Puerto Rico; (2) they are made effective through licences; and (3) they apply on the importation of the UHT -- the licence required is conditional on the importer complying with specific Puerto Rico requirements. Moreover, measures expressly covered by GATT Article XI do not become internal measures by virtue of the operation of the interpretive note ad GATT Article III.⁴⁶

4.5 If Puerto Rico Regulations 138 and 5 were interpreted and applied in a fair manner, however, Québec UHT milk would meet all requirements and Puerto Rico would not find reason to deny the import, sale and distribution licenses. Puerto Rico has interpreted and applied the regulations in a manner which has created conditions for compliance which cannot be met⁴⁷. Essentially, Puerto Rico would require Canada to join the National Conference on Interstate Milk Shipments (NCIMS) and to adopt the U.S. Pasteurized Milk Ordinance (PMO). The Regulations therefore operate as a prohibition on importation.⁴⁸

4.6 Alternatively, Canada argued that the Puerto Rico licensing requirements breach GATT Article III as incorporated into the FTA under Articles 501 and 502. Even though the required license affects Québec UHT milk at the border, it also applies to the internal sale and distribution of the product. As such, under the terms of GATT Article III:4, the principle of national treatment must be applied. It is not permitted to treat an imported product less favourably than a like domestic product. Underlying this rule is the goal of providing equal opportunity of market access to imported and domestic products.⁴⁹ The precise manner in which the national treatment principle has been violated lies in Puerto Rico's interpretation and application of Regulations governing the production, sale, distribution and import of milk. Puerto Rico has chosen to interpret the condition that milk from outside Puerto Rico be "elaborated and processed under substantially similar regulations"⁵⁰ as meaning that the PMO standards must be employed. This interpretation is not consistent with the definition of "equivalent" under Article 711 of the FTA and therefore denies the fundamental principle of national treatment.⁵¹

4.7 Canada further argued that even though prima facie the Puerto Rico Regulations apply equally to domestic and imported milk, this de jure equality masks de facto discrimination because it is simply impossible for the imported Québec UHT milk to meet the requirements which can be routinely met by like U.S. products. The reason for the inability to meet the requirements is the inflexible interpretation accorded the Regulations by Puerto Rico authorities and their refusal to adopt measures which would allow the Québec producer to demonstrate the equivalence of Québec and Puerto Rico health and safety standards for the production of milk.⁵²

4.8 Canada submitted that the denial of sales and distribution licenses to Québec UHT milk further breaches GATT Article III:1 by affording protection to domestic production. By interpreting and applying the Regulations so as to exclude from the Puerto Rico UHT milk market the largest non-Puerto Rico UHT producer, the authorities have afforded protection to domestic producers. While, on their face, the Puerto Rico regulations appear to apply the same standards to domestic and imported products alike, in fact, they are being interpreted and applied in a manner that affords protection to domestic UHT production.⁵³

4.9 Canada argued that (i) by requiring an FDA-certified inspection but refusing to certify Canadian or Québec inspectors to carry out such inspections, (ii) by requiring that the regime established for the production of UHT milk from Québec be identical to that of the PMO, and (iii) by requiring that Canada adopt a U.S. system of verification and oversight and join the NCIMS, the United States imposed conditions that neither Canada nor the producer of the UHT milk from Québec could meet.⁵⁴

4.10 Canada also submitted that the Puerto Rico Regulations as interpreted and applied breached Article 703 of the FTA which requires the parties to "facilitate trade in agricultural products" by working together "to improve access to each other's markets through the elimination or reduction of import barriers". Because the Puerto Rico Regulations were applied to create a new import barrier to Québec UHT milk, where none had existed before, Article 703 was violated. In addition, the failure of Puerto Rico to agree to an expeditious equivalency study before the exclusion of the UHT milk from the market was itself a violation of the obligation to "work together" to improve market access.⁵⁵

4.11 Canada argued that the Puerto Rico measures should be treated as technical regulations and inspection procedures subject to a requirement under FTA Article 708.1(a) to make such measures equivalent in Canada and the USA. Article 708.1 recognises the legitimacy of technical regulations and standards "to protect human, animal and plant life" but goes on to state that "the Parties shall seek an open border policy with respect to trade in agricultural, food, beverage and certain related goods". In implementing that policy, the parties are to be guided by "principles" including the duty to "make equivalent their respective technical regulatory requirements and inspection procedures" where full "harmonisation" is not feasible.⁵⁶

4.12 Canada also submitted that in refusing to carry out a timely equivalency study to assess whether the Québec production standards for UHT milk are equivalent to Puerto Rico's standards, the United States breached Article 708.1(a). Equivalency should be measured according to the definition of "equivalent" found in Article 711 of the FTA, that is, "having the same effect".⁵⁷

4.13 Furthermore, under Article 708.1(c), the Parties to the FTA agree "to establish equivalent accreditation procedures for inspection systems and inspectors". Puerto Rico's insistence that only FDA-certified inspectors could be employed to evaluate the Québec UHT milk failed to meet the requirements of Article 708.1(c).⁵⁸

4.14 Canada further submitted that the Puerto Rico measures failed to comply with FTA Article 708.2(a) which imposes binding obligations upon Canada and the United States:

This provision contains two separate elements: to work towards the elimination of existing technical regulations and standards which constitute "an arbitrary, unjustifiable or disguised restriction on bilateral trade"; and to prevent the introduction of any such new regulations. The Puerto Rico Regulations were adopted after the ratification of the FTA and therefore constitute new technical regulations or standards. The result of the interpretation and application of those Regulations is the arbitrary and unjustifiable exclusion from the Puerto Rico market of Québec UHT milk which had been imported and distributed in Puerto Rico for some 14 years.⁵⁹ To introduce new standards the United States would have to justify its action with more than a mere assertion that the standards are necessary for reasons of health and milk quality.⁶⁰

4.15 Canada submitted that UHT milk from Québec already met the standards of the U.S. Low-Acid Canned Food Regulations⁶¹; as these regulations were merely incorporated into the PMO (Part II, Section I:N1), no material change in aseptic processing was required under the new Puerto Rico Regulations. The new Regulations would not provide greater protection for public health, but amounted merely to technical regulations which had the effect of excluding Québec UHT milk from the Puerto Rico market.⁶² The Puerto Rico measures are also unjustifiable because there are other less trade restrictive measures which could have been taken to achieve the desired result of protection of public health.⁶³

4.16 The obligation contained in Article 708.2 must be interpreted in good faith as required by Article 31 of the Vienna Convention on the Law of Treaties, and in the light of the principles set out in Article 708.1. A reasonable interpretation of Article 708.2 would require that once a party has made out a prima facie case that the introduction of new standards was arbitrary, unjustifiable or a disguised restriction on trade, the burden of proof would shift to the party which has introduced the standard to justify its existence.⁶⁴ Furthermore, a commonsensical interpretation of Article 708.2 would demand that the United States cannot determine equivalence with sole reference to its domestic law when the applicable standard has been set out expressly in a binding international treaty, Article 710 of the FTA. Nor can the United States defer to the interpretation of equivalence offered by Puerto Rico, even if that determination is constitutionally valid under domestic law. Article 27 of the Vienna Convention provides that "[a] party may not invoke the provisions of its internal law as justification for its failure to perform a treaty."⁶⁵

4.17 Canada submitted that the Puerto Rico denial of an import, sales and distribution license to Québec UHT milk could not be justified under GATT Article XX(b), the exception relating to the protection of health. That exception must be strictly construed. Moreover, the burden of proof under Article XX lies on the party seeking to invoke the exception. In any event, Article XX(b) is inapplicable on the facts because even though the Puerto Rico Regulations are prima facie related to health protection, the manner in which they are being interpreted and applied suggests that they are actually disguised restrictions upon trade. This interpretation is bolstered by the fact that the regulations are not necessary to achieve the health protection objective. Other avenues were and are available to guarantee the purity of an imported UHT milk supply. Such measures had indeed been employed by Puerto Rico authorities for 14 years, during which time no complaint had ever been lodged against the purity of Québec UHT milk. Article XX requires that when less trade restrictive measures are available to meet legitimate policy goals, those measures must be pursued.⁶⁶

4.18 Canada further argued in the alternative that even if the Puerto Rico measures were found to be consistent with U.S. obligations under the FTA, the application of the measures nullifies and impairs the benefits Canada could reasonably have expected to achieve under the FTA. Nullification and impairment, as defined by FTA Article 2011, should be measured in the light of GATT practice which requires that the parties have negotiated a tariff concession, that one party has subsequently introduced a government measure which has upset the competitive relationship between like imported and domestic products, and that this measure could not reasonably have been anticipated at the time of the negotiation of the tariff concession. Canada submitted that on the facts, all three conditions had been met in the present case.⁶⁷

4.19 Finally, Canada argued that the Québec UHT milk should be allowed to re-enter the Puerto Rico market pending the completion of any equivalency study. The Québec milk is safe and healthy, and only this approach could ensure that the Québec producer does not permanently lose its market share.⁶⁸

To Continue with Submissions of the United States

³⁶ Letter from the Canadian Minister of International Trade to the United States Trade Representative, dated July 9, 1992 (Canadian Exhibit U).

³⁷ Letter from Acting USTR Julius L. Katz to the Canadian Minister for International Trade, dated August 24, 1991 (Canadian Exhibit V).

³⁸ Letter from the Canadian Minister for International Trade to the United States Trade Representative, dated September 16, 1992 (Canadian Exhibit W).

³⁹ Letter from the Canadian Minister for International Trade to the United States Trade Representative, dated September 17, 1992 (Canadian Exhibit X).

⁴⁰ Letter from Acting USTR Julius L. Katz to the Canadian Minister of International Trade, dated September 25, 1992 (Canadian Exhibit Y).

⁴¹ Ibid.

⁴² Letter from the Canadian Minister for International Trade to the United States Trade Representative, dated October 15, 1992 (Canadian Exhibit Z).

⁴³ Letter from the United States Trade Representative to the Canadian Minister for International Trade, dated November 9, 1992 (Canadian Exhibit AA).

⁴⁴ Canada's First Submission, p. 18, para. 44 and United States First Submission, p. 19, paras. 100-101.

⁴⁵ Canada's First Submission, pp 19-21.

⁴⁶ Canada's First Submission, p.22 and Canada's Supplementary Submission, pp 16-17.

⁴⁷ Canada's Supplementary Submission, p. 16.

⁴⁸ Canada's First Submission, pp 20-21.

⁴⁹ Canada's First Submission, pp 22-25.

⁵⁰ Section 11, Grade 'A' Pasteurized Milk Ordinance, 1989 Revision, U.S. Department of Human Services, pp 106-107.

⁵¹ Canada's Supplementary Submission, pp 15-16.

⁵² Canada's First Submission, p. 24.

⁵³ Canada's First Submission, p. 25.

⁵⁴ Canada's First Submission, para. 69.

⁵⁵ Canada's First Submission, p. 26.

⁵⁶ Canada's First Submission, p. 27.

⁵⁷ Canada's First Submission, p. 28.

⁵⁸ Canada's First Submission, p. 28.

⁵⁹ Canada's First Submission, p. 29.

⁶⁰ Canada's Supplementary Submission, p. 19.

⁶¹ 21 CFR 113.

⁶² Canada's Supplementary Submission, p. 9.

⁶³ Canada's First Submission, p. 29.

⁶⁴ Canada's Supplementary Submission, p. 19.

⁶⁵ Canada's Supplementary Submission, p. 18.

⁶⁶ Canada's First Submission, pp 30-31.

⁶⁷ Canada's First Submission, p. 33.

⁶⁸ Canada's Supplementary Submission, p. 21.