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

b. Submissions of the United States

4.20 The United States argued from the agreed proposition that FTA Article 708.1 explicitly affirms the right of the parties to promulgate technical regulations and standards to protect human, animal and plant life. Accompanying this right is the further right to upgrade such health standards in the light of improvements in scientific and public health knowledge. It falls upon the producer to tailor its product to the market, including the legitimate health regulations applicable within the market.⁶⁹

4.21 The burden of proof in the case rests upon Canada, as it is the party alleging a breach of treaty obligations.⁷⁰

4.22 The United States submitted that GATT Article XI has no application to the situation of Québec UHT milk in Puerto Rico. The license requirements imposed by Puerto Rico do not amount to an import prohibition or restriction, but are entirely internal measures applicable to all producers of milk, domestic or foreign. Even though the license requirements apply at the border for imported products, the requirements do not single out imported products, but relate to all milk products, no matter their origin.⁷¹ Puerto Rico applies a single licensing requirement for the import, sale and distribution of milk.⁷²

4.23 A construction of Article XI which would bar any import restrictions, even when identical to domestic standards, would undermine the sovereign power of states to set appropriate health and safety standards to protect their respective populations.⁷³

4.24 The relevant GATT provision is Article III, incorporated into the FTA through Articles 501 and 710, which governs "laws, regulations and requirements affecting the internal sale, offering for sale, [and] distribution" of products, including milk. The Puerto Rico Regulations are purely internal requirements because they apply equally to domestic and imported milk. This interpretation is supported by the Interpretive Note Ad Article III which states that "any law, regulation, or requirement...which applies to an imported product and the like domestic product and is...enforced in the case of the imported product at the time or point of importation, is nevertheless to be regarded as an internal...law, regulation, or requirement...and is accordingly subject to the provisions of Article III". Consistent GATT and FTA practice also supports this view of the relative scope of Articles XI and III.⁷⁴

4.25 The United States further argued that the denial of Puerto Rico licenses to Québec UHT milk was fully consistent with GATT Article III:4 which imposes a "national treatment" standard. The Puerto Rico Regulations apply equally to imported and domestically produced milk; imported milk is treated "no less favorably" than the like domestic product. In every case, the relevant standard is the Pasteurized Milk Ordinance (PMO), which is incorporated into Puerto Rico law through Regulations 5 and 138. The Québec UHT milk simply did not meet that universally applicable standard.⁷⁵

4.26 To meet the PMO standard, the Québec milk producer would have had to demonstrate that its UHT milk was produced and pasteurized under regulations that are "substantially equivalent" to the PMO. "Substantial equivalence" under PMO Section 11 has been interpreted by the National Conference on Interstate Milk Shipment (NCIMS) to mean that an equivalent system must be identical to or stricter than the requirements of the PMO. This interpretation applies to all milk producers, and is the appropriate interpretation in the present case.⁷⁶

4.27 The Québec producer was not able to demonstrate the required equivalence, and should not be exempted from the application of a requirement which applies to all of its competitors.⁷⁷ The United States position is that Lactel milk exported to Puerto Rico must meet PMO standards, unless Puerto Rico has determined that the government of Québec's standards are equivalent to the PMO.⁷⁸

4.28 In any event, border inspections of individual shipments of milk could not have amounted to substantial equivalence with the PMO because that system is rooted in production standards and prevention to protect the public health. Border inspections would provide an inadequate level of protection because they do not enforce strict industry standards, but simply assess whether any given shipment of milk is contaminated. Moreover, given the huge volume of transborder shipments of food and agricultural products, border inspection of all shipments is impractical, particularly where, as in the case of UHT milk, the product is in sealed boxes.⁷⁹ Neither the FTA nor the GATT create obligations to provide special procedures outside the standard regulatory regime to give more favourable treatment to a Canadian producer than that accorded to Puerto Rico or U.S. milk producers.⁸⁰ In any event, border inspection procedures cannot assure equivalent levels of safety or quality. Canada itself does not permit border inspections in administering its own dairy safety programme and imposes process and inspection requirements directly analogous to those of Puerto Rico.⁸¹

4.29 Whatever legal standard of equivalency should be applied, the Panel cannot conduct its own equivalency assessment, comparing Puerto Rico and Québec standards for the production of UHT milk. Any such assessment would fall outside the scope of the Panel's Terms of Reference, and would be fraught with risk of error.⁸² The final decision concerning equivalency rests in the discretion of Puerto Rico authorities. Nothing in the FTA dislodges this exercise of sovereignty. Article 708.3 provides that a party is required to accept certification by the other party only after ''the Parties have harmonized or accepted the equivalence of each other's inspection systems, certification procedures, or testing requirements''.⁸³

4.30 The United States argued that Article 703 of the FTA is hortatory, simply requiring the Parties to "work together" toward an ultimate goal of reciprocal market access. The Article imposes no binding obligation immediately to eliminate all import barriers, nor does it relate to technical standards. The Working Groups set up under Article 703 in which the United States participates, more than satisfy its obligations.⁸⁴

4.31 The United States also submitted that Article 708 should be interpreted to create only a "best efforts" obligation to work to integrate technical standards. The Preamble to the FTA emphasises the need to preserve "the Parties' flexibility to safeguard the public welfare." This emphasis serves to aid in the appropriate contextual and purposive interpretation of Article 708 as a whole.⁸⁵ The Article is cast in facilitative, not mandatory, terms: the parties agree to "seek", to be "guided by", and to apply "principles".

4.32 More particularly, the "principles" set out in Article 708.1, including the principle of prospective equivalency of technical standards, do not constitute obligations, but long-term desiderata. Therefore, they are not justiciable, and do not properly fall to be applied by a dispute settlement panel.⁸⁶ Working Groups are now seeking to further the concept of equivalency, but this merely underscores the non-binding character of Article 708.1. The Parties to the FTA retained ultimate authority to determine equivalency of technical standards. The United States more than met its obligations under Article 708.1 by offering to conduct an expedited equivalency study.⁸⁷

4.33 The United States also discussed Article 708.2(a) which provides that the Parties shall prevent the introduction of new technical standards that would amount to an arbitrary, unjustifiable or disguised restriction on trade. It was argued that this provision does not prevent a Party from upgrading its health standards. The mere fact that an enhanced standard results in the exclusion of sub-standard products does not render the new standard arbitrary or unjustifiable.⁸⁸ To show that the new Regulations were not arbitrary, unjustifiable or adopted or applied for the purpose of restricting trade, the United States has related the Regulations to a legitimate policy objective, the safety and quality of the milk supply.⁸⁹

4.34 The United States also noted that it had suggested various reasonable short-term options by which the Québec producer could demonstrate compliance with the Puerto Rico measures, pending a full equivalency study. These options had not been taken up. Canada itself requires that imported milk be processed under technical and inspection requirements "at least equivalent" to the Canadian regulations. Canada is not in a position to argue that a similar approach adopted by Puerto Rico is arbitrary or unjustifiable.⁹⁰

4.35 As an alternative submission, the United States submitted that if it had breached any provision of the FTA, the prima facie breach should be treated as a legitimate exception under GATT Article XX which allows states to adopt measures "necessary to protect human, animal or plant life or health", as long as such measures are not "arbitrary or unjustifiable discrimination between countries where the same conditions prevail". To be "necessary", a regulation relating to public health need not be the least trade restrictive measure available.⁹¹

4.36 The United States argued that Canada suffered no nullification or impairment of its benefits under the FTA because Canada could not reasonably have assumed that Puerto Rico would never upgrade its milk import, sale and distribution regulations. Because Article 708 of the FTA implicitly allows Parties to modify their technical standards, the Puerto Rico decision to implement the PMO could not have been a surprise to Canada, particularly as this standard applies in all fifty U.S. states. This interpretation is supported by the reference in a 1990 document of the bilateral Working Group on Dairy Trade that the U.S. and Canada believed that there was "no trade expected" in sterilised milk.⁹²

4.37 Finally, the United States argued that the Québec milk should not be permitted access to the Puerto Rico market until after the successful completion of an equivalency study. There is no evidence, apart from the mere assertion by Canada, that Québec production standards are equivalent to the Puerto Rico standards. Puerto Rico must be able to prevent access to its market until it is satisfied that Québec UHT milk is produced under equivalent standards. Any other approach would place trade considerations ahead of legitimate public health concerns.⁹³

5. Answers To The Terms Of Reference

(a) General Considerations

5.1 This dispute relates to the manner in which a new health regulation, relating generally to milk production, was applied to UHT milk from Québec. Both Parties have urged upon the Panel the potential significance of a recommendation in this, the first dispute under the FTA dealing with standards. While the Panel is conscious of its responsibilities in this regard, it wishes to make a few cautionary remarks, by way of introduction, with respect to its understanding of the nature of this dispute.

5.2 Standard-setting is a significant prerogative of States. The issues posed by standards are all the more important as the public becomes aware of the need to protect public health through wise standards, governing products and production processes. It is also clear to the Panel that standards have an effect upon imported goods which cannot be ignored. In a global economy and a fortiori in the special context of the Canada-U.S. Free Trade Agreement, cooperation and mutual consideration must be present if the imperatives of free trade are to be reconciled with the imperatives of public health.

5.3 The terms of reference direct the Panel to determine whether the prohibition within the Commonwealth of Puerto Rico, since December 31, 1991, on the importation, distribution, and sale of UHT milk produced in Québec is inconsistent with the obligations of the United States under the FTA, including, in particular, Articles 407, 501, 502, 703, 708, 710 Schedule 11 of Chapter 7 and Article 2011. The governing legal principles are to be found in the FTA and related principles of the GATT. In other words, this is a dispute as to international obligations and not with respect to the legality under domestic law of enhanced standards.

5.4 The Panel wishes to make three specific points with respect to this dispute. In the first place, the dispute relates not to the validity of the PMO or related Regulations adopted by the Commonwealth of Puerto Rico. There is no question as to the right of the United States and Puerto Rico to adopt these standards. Secondly, the dispute relates to UHT milk. It does not relate to fresh milk or other aspects of milk marketing in Puerto Rico. Thirdly, the dispute relates to the manner in which the authorities of the United States and Puerto Rico responded to requests by Canada that UHT milk from Québec might continue to be marketed in Puerto Rico after the adoption of the PMO and related Puerto-Rico regulations. In other words, this dispute turns upon the interpretation and application of the PMO and related Puerto-Rico regulations in relation to UHT milk imported from Québec and not upon the legitimacy of the standards themselves.

5.5 Finally, in the view of the Panel, the central issue of this dispute turns upon the question of equivalency, the manner of determining equivalency, and the appropriate standard by which equivalency is to be judged with respect to agricultural products under the FTA.

(b) FTA Articles 407, 710/GATT Article XI

5.6 In its written and oral submissions, Canada argued that the refusal of the Puerto Rico Departments of Health and Agriculture to renew the permit which would authorize Lactel to import UHT milk into Puerto Rico after December 31, 1991, constituted a violation of Articles 407 and 710 of the FTA and Article XI:1 of the GATT. Canada argued at paragraph 61 of its Submission that "by refusing to certify an officer to rate the Québec UHT and by not offering other reasonable alternatives (such as inspection of the milk at the border), the United States and Puerto Rico are preventing Québec from complying with Regulations 138 and 5... As such, they (Regulations 138 and 5) operate as a prohibition on the import into Puerto Rico of the Québec UHT and are inconsistent with GATT Article XI:1." The United States, on the other hand, denied the proposition that these measures or their implementation could be characterized as quantitative restrictions. In the view of the United States the only applicable rules were Articles 501 and 502 of the FTA and the comparable Article III of the GATT dealing with national treatment of a domestic measure.

5.7 As the division of opinion within the earlier FTA Panel In the Matter of Lobsters from Canada⁹⁴ reveals, the distinction between a quota or a measure having the effect of a quota and a domestic measure enforced at the border is not always an easy one to make. In the Lobster Panel report, the majority characterized the U.S. rule prohibiting the importation of lobsters under a minimum size requirement as a domestic measure, while the minority considered it to be a quantitative restriction. Certain recent GATT decisions reveal that Article XI violations can arise out of what begin as essentially domestic measures. Thus, certain aspects of Canadian provincial liquor monopoly practices with respect to imported wine and spirits were deemed to violate Article XI.⁹⁵ The recent case involving a complaint by Mexico against the prohibition on the importation of tuna in the United States not certified to have been caught in a manner compatible with United States regulations, also involved a finding that the U. S. measures violated Article XI of the GATT.⁹⁶ However, in this case, the Panel is not convinced that the Puerto Rico regulations and their implementation can be characterized as quantitative restrictions.

5.8 The Panel has carefully studied the submissions of both Parties and supporting documents concerning the nature of the license to import, distribute and sell milk in Puerto Rico pursuant to Puerto Rico Regulations and the PMO. At the oral hearing, the Panel asked for further clarification as to whether there was in fact a separate import licence required by these Regulations or whether there was a single licence which dealt with every aspect of the importation, sale, and the distribution of milk in Puerto Rico, pursuant to these Regulations. Analysis of the Regulations, of the response of the Parties during the Hearing and subsequent additional material furnished in response to the Panel's questions make it clear that the Puerto Rico regulations do not involve a separate import licence but rather involve a general licence which permits the licence holder to import, distribute and sell milk which conforms to the standard of the Regulations and the PMO. In the view of the Panel, this scheme is more properly characterized as a domestic measure than as a quantitative restriction. For this reason the Panel is of the view that there has been no violation of FTA Article 407 or GATT XI by the United States.

(c) FTA Articles 501 and 502/GATT Article III

5.9 Canada alleges that the United States has violated Articles 501 and 502 of the Free Trade Agreement and thereby Articles III:1 and III:4 of the GATT in its interpretation and implementation of the PMO and Puerto Rico Regulations 5 and 138. The United States has answered this claim by asserting that its application of the relevant regulations has been entirely in conformity with the relevant articles of the FTA and GATT.

5.10 Canada alleges that by denying Lactel the opportunity to prove that its UHT milk was produced under regulations having the same effect as the PMO, the Puerto Rico Regulations 5 and 138 were interpreted and applied in a way which denied national treatment to Québec UHT milk and in a manner which afforded protection for milk produced in Puerto Rico and elsewhere in the United States.

5.11 GATT Article III involves two important dimensions. Article III:4 of the GATT requires that the products of the territory of any contracting party imported into the territory of another contracting party shall be accorded national treatment with respect to "all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use." In paragraph III.1, is to be found the requirement that "domestic laws, regulations and requirements affecting the internal sale... should not be applied to imported or domestic products so as to afford protection to domestic production." The submissions and counter-submissions of the Parties and their oral arguments before the Panel turned on these two dimensions of Article III.

5.12 Given its approach to the application of GATT Article XI in this context, the Panel has no difficulty with the proposition that the PMO and Puerto Rico Regulations 5 and 138 constitute internal measures. This view is reinforced by the Interpretative Note ad GATT Article III. In the view of the Panel the measures in question are such as are contemplated in the Interpretative Note ad GATT Article III. The Panel therefore considers it appropriate to consider the Parties' arguments under GATT Article III.

(i) GATT Article III:4

5.13 Canada alleges that UHT milk from Québec was afforded less favourable treatment than UHT milk produced in the United States. The United States responds that it has never required anything more of UHT milk from Québec than compliance with the production and quality standards of the PMO and the implementing Puerto Rico regulations and thus has always approached this matter on the basis of strict equality.

5.14 The application of Article III to standards designed to protect public health, such as the PMO and Puerto Rico Regulations 5 and 138, is a matter of considerable sensitivity and difficulty. The Panel believes that the starting point of any analysis must be the principles of non-protection and sovereignty which lie at the heart of Article III. In the view of the Panel, Article III affords broad discretion in the setting of health standards applicable to imported products. The only qualification on the sovereign right of States to impose such standards upon imported products is that these standards must apply equally to domestic and to imported products and, secondly, that they should not be applied in a manner calculated to afford protection to domestic production.

5.15 The application of the concept of equality in a given context is always a matter of considerable difficulty and debate. However, since the time of Aristotle, at least two principles have been widely recognized with respect to the definition of equality. Firstly, equal treatment involves according the same treatment to the same facts. Secondly, equal treatment of dissimilar facts will not produce equality.⁹⁷ The interpretation of the GATT has reflected both these propositions.⁹⁸

5.16 The standard of treatment required by Article III.4 of the GATT has been commented upon by a number of Panels. The classic description is to be found in the Panel report on Italian Discrimination Against Imported Agricultural Machinery⁹⁹. It states that "the intent of the drafters was to provide equal conditions of competition once goods had been cleared through customs". More recently, a Panel report¹⁰⁰ described national treatment as "a requirement to accord imported products competitive opportunities no less favourable than those accorded to domestic products." In 1992, a GATT Panel stated that "[t]he Article III.4 requirement is one addressed to relative competitive opportunities created by the government in the market..."¹⁰¹ Another pertinent discussion of the standard of treatment of imported products required by Article III.4, and III.1 is to be found in EEC - Measures on Animal Feed Proteins.¹⁰²

5.17. Has there been denial of equality of treatment in the application of the PMO as required by Article III:4 in the circumstances of the case? The difficulty in answering this question lies not so much in the applicable general principles, which the Panel believes to have been well enunciated, as in their application to the specific context of product standards. This would seem to be a question best addressed in the context of the FTA. Standards in general and agricultural product standards in particular are dealt with in the FTA Chapters 6 & 7. In these circumstances, the Panel considers that it is preferable to base its determinations in this case upon the more specific provisions of the FTA rather than upon the general principles of the GATT.

5.18 The Panel therefore abstains from making any determination based upon GATT Article III:4.

To Continue with Article III.1

⁶⁹ United States First Submission, pp 19-20.

⁷⁰ United States First Submission, p. 20.

⁷¹ United States First Submission, p. 21.

⁷² United States Supplemental Submission, p. 12.

⁷³ United States First Submission, p. 24.

⁷⁴ United States First Submission, pp 22-23.

⁷⁵ United States First Submission, pp 24-25.

⁷⁶ United States First Submission, p. 27 and United States Supplemental Submission, p. 10.

⁷⁷ United States First Submission, p. 28. 

⁷⁸ United States Supplemental Submission, p. 10, fn 16.

⁷⁹ United States Supplemental Submission, pp 15-16, paras. 48-51.

⁸⁰ United States First Submission, p. 27.

⁸¹ United States Supplemental Submission, pp 9-11 and para. 36.

⁸² United States Supplemental Submission, p. 7.

⁸³ United States First Submission, p. 32 and United States Supplemental Submission, p. 7, para. 22.

⁸⁴ United States First Submission, pp 32-33.

⁸⁵ United States Supplemental Submission, p. 3.

⁸⁶ United States First Submission, p. 34.

⁸⁷ United States Supplemental Submissions, pp 7-8, paras. 22, 23, 27.

⁸⁸ United States First Submission, p. 35.

⁸⁹ United States Supplemental Submission, p. 4.

⁹⁰ United States Supplemental Submission, pp 11-12.

⁹¹ United States First Submission, p. 37.

⁹² United States First Submission, pp 38-39.

⁹³ United States Supplemental Submission, p. 13-14.

⁹⁴ Final report of the Panel, May 25, 1990, USA-89-1807-01

⁹⁵ Panel on Import, Distribution and Sale of Alcoholic Drinks by Canadian Provincial Marketing Agencies, February 5, 1988, GATT, BISD 35S/37.

⁹⁶ United States restrictions on Import of Tuna, GATT Doc. DS21/R September 3, 1991. This Panel Report has not been adopted by the GATT Council.

⁹⁷ Aristotle, Nicomachean Ethics, Book 5, lines 1131a 21 -30 trans T. Irwin, 1985, Hackett Publishing Co; Politics, Book 3, Ch.9, lines 1280a ff.

⁹⁸ See Section 337 of the U.S. Tariff Act GATT BISD 36S/345 at para. 5.10.

⁹⁹ GATT BISD 7S/60 (1959) at para 13.

¹⁰⁰ Canada - Import Distribution and Sale of certain Alcoholic Drinks by Provincial Marketing Agencies, Report of the Panel October 16, 1991 at para.5.6.

¹⁰¹ United States - Measures Affecting Alcoholic and Malt Beverages, Report of the Panel GATT Doc DS23/R, March 16, 1992, at para. 5.31 (This Panel report has not been adopted by the GATT Council).

¹⁰² GATT, BISD 25S/49 at paras 4.1 - 4.12.