As part of its green transition, the United States recently introduced a tax-break scheme that favoured domestically produced electric vehicles. This has excluded Asian automakers, which currently produce a significant number of the electric vehicles purchased in the U.S., leading them to accuse the Biden administration of breaching international law. Trade lawyers dissect the potential disputes arising from the law, the legal remedies in place, and the ramifications ahead.  

Unfazed by energy security woes compounded by oil shocks and the Russian-Ukraine war, the Biden administration has stepped up efforts to bolster America’s green credentials. In August, the White House signed into law the Inflation Reduction Act of 2022 (the IRA), which dedicated more than $370 billion to boost domestic energy and transmission projects and promote a sustainable economy.

While the IRA’s effect on curbing inflation remains to be seen, it was touted as the largest climate and energy investment in U.S. history. Notably, the law heralded a tax-break scheme for electric vehicles aimed at supporting the domestic automobile industry. American consumers are entitled for up to $7,500 in tax credit if they purchase sustainable vehicles that are assembled in North America.

The scheme has sparked mixed reactions. Proponents hail the measures as imperative in spurring America’s energy transition and bolstering supply chain security to compete with China, the current dominant player in the EV field. Bloomberg projects that by 2030, over half of passenger cars sold in the U.S. will be electric thanks to the incentives.

But the requirements have narrowed the list of qualifying EV models to approximately one-fifth of the universe of available models globally. As a result, major automakers in Asian countries, many of which are key U.S. trading partners, are expressing grievances that could deteriorate into disputes.

Under the new rules, Japan’s Toyota and Hyundai of South Korea are among those dealt the heaviest blows, as all their environmentally friendly vehicles are currently manufactured in non-U.S. plants. Seoul and Tokyo have lodged diplomatic protests with the White House, threatening to strain America’s alliance in the Asia Pacific region.

The political headache is not the only challenge facing policymakers in Washington. South Korean and Japanese officials admonished the Biden administration for running afoul of bilateral free trade agreements (FTAs) and rules promulgated by the World Trade Organisation (WTO), whose system the U.S. helped architect.

“The IRA implicitly calls into question America’s commitment to the pillars and principles upon which the WTO is built, namely non-discrimination, national treatment, tariffs over content requirements, and more,” says Robert Kossick, an international trade lawyer at Harris Bricken. “At a minimum, the law suggests the ascendance in the U.S. of a managed, as opposed to a rules-based, approach to trade.”

SAFEGUARDING INTERESTS

Kossick lays out the existing legal mechanisms safeguarding the interests of non-U.S. automakers. “For automakers from countries with U.S.-focused FTAs, including South Korea, dispute resolution mechanisms in said FTAs can provide protection in the form of recourse,” he says.

Maria Tan Pedersen, a partner at Dechert, further points out that investment treaties may grant non-U.S. automakers rights as foreign investors. “These treaties might, for instance, require the U.S. to afford such investors treatment that is no less favourable to that afforded to investors from other states; guarantee that such investors are treated the same as domestic investors in similar circumstances; and ensure that such investors are not subject to unfair or unequitable treatment,” she says.

When disputes arise, these treaties open the door for investor-state arbitration for qualifying non-U.S. carmakers, which can “allege that the discriminatory treatment accorded under the U.S. law violates the legitimate expectations of the investor,” Kossick notes.

“Should a claim be established, the arbitral tribunal has a broad discretion to determine compensation or other relief,” adds Pedersen.

For markets which didn’t enter into free trade agreements with the U.S., among them Japan and China, Kossick suggests that they resort to dispute settlement mechanisms embedded in various WTO agreements by filing a complaint to the trade body.

“The main foreseeable allegation is a violation of Article III of the General Agreement on Tariffs and Trade (GATT). This would emphasise the discriminatory nature of the final assembly and content requirements of the U.S. EV tax credit scheme,” Kossick notes, adding that countries in this category can also allege that the law is inconsistent with member commitments under the Agreement on Trade-Related Investment Measures.

But Kossick cautions against seeking settlement under the Agreement on Subsidies and Countervailing Measures, as the claim “may be more difficult to sustain given the fact that China and other countries also offer EV tax credits, albeit without potentially discriminatory assembly and content requirements.”

In the scenario where a state differs with the decision of the WTO dispute settlement panel, the matter will be presented in front of the Appellate Body. Pedersen is concerned with the limited enforcement power that the Body possesses due to a dwindling meet quorum resulting from the U.S. blockage of new member appointments.

Kossick offers a different take. “While the Appellate Body has been sidelined, the organisation’s dispute panels are still convening and issuing panel reports. These countries could be in a position to impose retaliatory tariffs against the U.S.” shall their complaints prevail, he notes.

LINES OF DEFENCE

There are several lines of defence that the U.S. can adopt in the wake of a potential WTO complaint, according to Kossick. For instance, the government can argue that the final assembly requirement underpinning the EV tax-break scheme is not a domestic content requirement. It may also justify the law by labelling it a measure related to a trade area, conservation of natural resources, or essential national security interests, and thus seek eligible exemptions under the GATT.

Though legal avenues exist, few favour the adversarial, sometimes protracted, process. Kossick says relevant parties should prioritise negotiation and consultation before filing any complaints to reduce conflicts.

However, it is not only the U.S. government that could be embroiled in a legal labyrinth. Asia-based automakers are also faced with mounting risks of dispute with third parties due to the EV mineral sourcing criteria set by the IRA. Starting in 2023, EVs are required to have at least 40 percent of their critical minerals for batteries sourced in the U.S., or countries that have FTAs with the U.S. That threshold is set to rise to 80 percent by 2026. Vehicles that source battery component or critical minerals from a “foreign entity of concern,” such as China and Russia, will also be denied tax credits. The new rules put the vast majority of EV manufacturers at a tight spot as 75 percent of all lithium-ion batteries and 50 percent of battery refining materials currently come from China.

Pedersen fears the policy may expose Asian carmakers to commercial liabilities.

“Some Japanese and South Korean-headquartered automobile manufacturers, for instance, have already started focusing their automotive and battery manufacturing in the U.S.,” she says. “Such efforts may disrupt existing arrangements with third parties and require the renegotiation of pre-existing agreements, potentially leading to commercial disputes over alleged breaches of contract. Such disputes may lead to litigation or commercial arbitration claims, depending on the contractual dispute resolution clauses.”

According to Kossick, a reliable and robust traceability regime scrutinising the source of EV battery-related critical minerals or components is vital in ensuring automakers’ eligibility in the long run. But the effort could be confronted by the “foreseeably non-cooperative postures by China and Russia,” he adds.

Navigating the legal complexities of the new EV levy scheme, Kossick says, requires lawyers to be well versed in a wide range of areas encompassing mining, customs and trade, environment law, and supply chain management.

Meanwhile, as parties seek enforcement of investment treaty protections, “demand for advice from legal professionals experienced in investor-state dispute settlement, both from a U.S. and an Asian perspective, may well increase,” adds Pedersen.