First softwood arbitration breaks new ground in old Canada-U.S. trade dispute

But it took less than three months for cracks to show, leading to a U.S.-launched demand for arbitration under the deal's dispute-settlement mechanism.

The process is being closely watched because it's the first real test of the agreement and the first time the London Court of International Arbitration - which handles mainly private commercial disputes - is being used as part of a state-to-state treaty to settle a disagreement.

An American victory in this new case could cost Canadian lumber exporters more than $100 million in penalties.

People involved in the softwood file agree this arbitration is an important test of the seven-year renewable lumber agreement.

"You want to see how the arbitration's going to work so the agreement can stand the test of time," says B.C. Forests Minister Rich Coleman, whose province accounts for more than half of Canadian lumber exports to the United States.

"This is certainly something that's going to tell us that."

If the process or the outcome leave a bad taste it could increase chances the deal won't survive past October 2008 - its minimum two-year term. Either country can give six-months notice it's exiting the agreement.

There's evidence the agreement has put only a thin veneer on top of the historic cross-border mistrust over lumber.

"This is an issue that is not a matter of an honest disagreement where an arbitration panel can help decide things from our perspective," says Zoltan van Heyningen, executive director of the U.S. Coalition for Fair Lumber Imports, which represents American producers.

"This is a clear violation of the agreement that should have been resolved in consultation."

The softwood agreement, which replaced punitive U.S. import duties, manages Canadian shipments through a combination of quotas and border taxes paid into Ottawa instead of Washington coffers.

The objective is to limit Canadian exports during periods of low prices and shrunken U.S. demand to protect American lumber producers who, through the politically well-connected coalition, have claimed for decades Canadian lumber is subsidized.

It was implemented last October but by January, U.S. officials were complaining Canada was already violating the agreement.

They allege Ottawa is under-collecting border taxes on B.C. and Alberta shipments and not applying a further penalty for exceeding their allotted export limits.

They also claim Ottawa, up to July, miscalculated the fixed quotas that apply to exports from Ontario and Quebec mills, leading to excessive shipments.

The Canadian industry puts the amount at between US$60 million to US$65 million if the U.S. complaint is upheld.

But the U.S. coalition estimates the total at about US$116 million.

That doesn't include any penalty levied against Ontario and Quebec producers for exceeding their quotas.

The coalition, always skeptical of Canadian intentions, believes the transgressions weren't innocent.

Asked if Canada was wilfully pushing the envelope, van Heyningen replies, "frankly, yes."

All that said, both sides are putting faith in the new, radically different dispute-settlement process.

The last softwood deal, which expired in 2001, foundered because it didn't include a way to resolve disputes.

That led to a legal war over subsequent U.S. duties fought on several fronts, principally through the North American Free Trade Agreement and the World Trade Organization.

Canada felt it was winning but opted to negotiate a new softwood deal, arguing even total victory didn't guarantee the Americans wouldn't simply launch new trade action.

Negotiators knew any new agreement would have to have a dispute-settlement mechanism.

But nasty fights over the makeup of NAFTA panels - the coalition even threatened a constitutional challenge because the panels put Canadians in the position of ruling on U.S. trade law in a process it felt was biased - led to the choice of the London Court of International Arbitration.

The London court isn't a public institution like, say, the International Court of Justice in The Hague.

It's actually a not-for-profit company geared to resolving commercial disputes.

It's the first time recourse to the London court has become an integral part of a state-to-state treaty, says Prof. Roger Alford, an arbitration law expert at Pepperdine University in Malibu, Calif.

"Two states are agreeing to submit to binding international arbitration using rules that were designed almost exclusively with private parties in mind," Alford, whose experience includes advising the tribunal that helped Holocaust survivors recover money from dormant Swiss bank accounts, wrote on the Opinio Juris legal blog.

"If this arbitration is successful, perhaps we will see more instances of states opting for this approach," Alford wrote.

Alford said he is not criticizing the decision.

"I'm not saying it's a bad choice; it's just a very interesting choice," he said in an interview.

The players in softwood were undoubtedly attracted by the London court's efficiency and success rate, Alford said.

The softwood agreement promises arbitrations will be completed within six months of a panel being appointed. WTO panels, one of the more successful trade-dispute bodies, take two years.

Most softwood players believe the London court's rules can be adapted to this kind of state-to-state dispute.

But Washington trade lawyer Elliott Feldman, who has acted for Canadian lumber exporters in previous cases, thinks the industry and the provinces will be short-changed by the process.

Unlike NAFTA panels, they have no legal standing before the London court and must rely on Ottawa to argue their positions.

"Now it'll be federal lawyers defending provincial programs, about which they know nothing," said Feldman.

Ottawa is promising close consultation and Coleman said B.C. officials and lawyers are working closely with their federal counterparts.

"I'm not fussed about it. We have a pretty good working relationship there," the B.C. minister said, noting the province relied on the feds to argue softwood at the WTO.

Ontario is slightly less enthused.

"We're as happy as we can be under the circumstances," said Bill Thorton, assistant deputy minister for forests at the Ontario Natural Resources Ministry. "I'll confess that it's not an ideal situation. We would rather be there defending our own programs.

"But this is a trade agreement between the two countries and the federal government takes the lead role in that respect."

There's an irony too for the Americans, who bridled at having U.S. trade law governed by NAFTA panels.

Although the arbitration hearing will be held in North America, the London-based court operates under the British legal system, meaning any problems will go before a British court.

Alford said that would happen only when parties refuse to participate in a process they agreed to or defy the arbitration panel's decision.

Federal Trade Minister David Emerson and his counterpart U.S. Trade Representative Susan Schwab this month reaffirmed their commitment to comply with whatever ruling the panel makes.