Explained: The MFN Principle
The most-favored-nation provision is a chief pillar of fair trade
For free global trade, perhaps no language is more powerful than the Most-Favored-Nation clause.
A Most-Favored-Nation provision is a clause in a trade agreement between two parties. Generally, the clause states that if one party extends favorable treatment to a third party, it must also extend the same treatment to the party included in the MFN provision.
Most-favored-nation clauses promote fair competition and prevent economic discrimination among involved partners. By issuing an MFN clause, the playing field is leveled for all parties involved, and parties are encouraged to negotiate more favorable trade terms. The principle underlying the most-favored-nation provision has global applications.
Global Trade & Investment Applications
Many trade agreements, investment treaties, and bilateral trade treaties include MFN clauses to ensure that partners and investors are treated fairly and equally. If a country grants a certain tax break or investment protection to party, it must also extend the same benefits to investors from all other parties with which it has an investment or trade treaty. Here are some examples of global trade and investement agreements that contain an MFN clause.
World Trade Organization (WTO): The underlying principle of the MFN is a fundamental component of the WTO. Within the WTO, each member country must extend the same trade concessions and benefits to all other member countries. This promotes fair competition and prevents discrimination in global trade.
United States–Mexico–Canada Agreement (USMCA): The USMCA, which replaced the North American Free Trade Agreement (NAFTA) in 2020, includes an MFN clause. Per the USMCA, members are contractually obligated to extend the same favorable treatment to each other as it grants to any third country.
United States-Korea Free Trade Agreement (KORUS): KORUS, a bilateral trade agreement between the United States and South Korea, includes an MFN clause that requires each country to extend the same favorable treatment to the other as it grants to any third country.
Canada-European Union Comprehensive Economic and Trade Agreement (CETA): CETA is a trade agreement between Canada and the European Union that includes an MFN clause. Like other MFNs, it requires each party to extend the same trade benefits to the other as it grants to any third country.
Trans-Pacific Partnership (TPP): The TPP was a proposed (but not ratified) trade agreement between Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam, and the United States. Within it included an MFN clause; each member country was required to extend the same tariff reductions and other trade benefits to all other members.
Business Applications & Concerns
How MFN Clauses work in Business
While MFN clauses are a common feature of international trade and investment agreements, they are not as common between U.S. businesses. Information regarding relationships between U.S. businesses are oftentimes material and/or confidential, and it is difficult to pinpoint examples of specific instances where MFN clauses play a role in B2B relationships. However, MFN clauses may be included in contracts between businesses in industries with intense competition, or in industries where pricing is a key factor in partnerships.
- Healthcare: a hospital may negotiate an MFN clause with a pharmaceutical company to ensure that it receives the lowest possible prices for drugs compared to any other hospital that the pharmaceutical company supplies.
- Entertainment & Technology: Deals between cable operators and TV-channel owners have evolved in the last 15–20 years to address digital distribution rights. In some cases, the clauses limit how and where channel owners can make their programming available online.
MFN clauses can be used in certain industries or contexts with the intent to promote fair competition and ensure that all customers receive equal treatment. But, the intent of an MFN clause in business may not align with its implications in practice.
Antitrust Concerns — Squashing Nascent Competition
There is a concern that MFN clauses can be used in business to “quash nascent competition”. In 2012, the Justice Department conducted a wide-ranging antitrust investigation into whether cable companies acted improperly to limit online distribution. From the Wall Street Journal:
“The Justice Department also is investigating the contracts that programmers sign in order to be distributed on cable systems. Some contracts include so-called most-favored nation clauses, which make programmers give the biggest cable companies the best price they are offering anywhere, among other conditions. The Justice Department is questioning whether there are legitimate business reasons for such terms or whether they are intended to stop programmers from experimenting with other forms of online distribution, a person familiar with the matter said.”
The intent of the MFN clause in distribution contracts were designed not to promote fair trading practices, but to eliminate online distribution of video from services like Netflix and Hulu. (How did that work out?)
Antitrust Concerns — Price Fixing
Additionally, U.S. District Judge Denise Cote’s ruling in 2013 suggests that MFN clauses may not lead to lower prices for consumers.
In the early 2010s, technology giant Apple had contracts with major book publishers to ensure that Apple was receiving the lowest price — a price matching clause that mimicked an MFN.
According to the Wall Street Journal, “Cote [ruled] that the price-matching provision in Apple’s contracts with five major book publishers was part of a conspiracy to fix e-book prices. The contracts required the publishers to give the technology giant’s iTunes store the best deal in the marketplace on e-books.”
Ruled Judge Cote:
“[The MFN] eliminated any risk that Apple would ever have to compete on price when selling e-books, while as a practical matter forcing the publishers to adopt the agency model across the board.”
Assistant Attorney General Bill Baer, who oversees the division at the Justice Department, agreed with Judge Cote’s ruling.
“While most favored-nation clauses can be competitively benign, when they are used as a tool to engage in anticompetitive conduct that harms consumers, the Antitrust Division will take enforcement action,”
While the MFN provision in business-to-business contracts may have the intent to pass on cost savings to consumers, the U.S. Justice Department is starting to look out for provisions that threaten healthy competition.
Flavors of MFN Provisions
MFN provisions come in all shapes and sizes, tailored specifically to the contract in which it lives. Based on the spirit and intentions of the partnership, it may be helpful to adjust the specific language to align with the verbal agreement. Below are a few examples of how an MFN provision can be tailored to match the specific needs of the involved parties.
Asymmetric MFN
An asymmetric MFN clause is a one-way clause; it creates an asymmetry in the non-discrimination principle among involved parties.
Unlike a standard MFN clause, which requires a country to extend the same treatment to another country as it grants to any third country, an asymmetric MFN clause allows a country to receive more favorable treatment from another country without extending the same treatment in return.
- Example: An asymmetric MFN clause may allow a developing country to receive preferential treatment from a developed country (including lower tariffs or greater access to markets), without extending the same treatment in return. This is a useful tool for promoting economic development.
In some cases, asymmetric MFN clauses are prone to controversy. While some countries may see asymmetric MFN clauses as a legitimate tool for promoting development and reducing economic disparities, others may perceive asymmetric MFN clauses as a way for developing countries to gain an unfair advantage in trade. The use of asymmetric MFN clauses in international trade agreements remains a hotly-contested debate topic among policymakers and economists.
Imperfect MFN
An imperfect MFN clause allows a party to exclude certain benefits or protections that it grants to a third party from being extended to the party with the narrow MFN clause. This type of clause can be useful when one party wants to limit the scope of its obligations under the MFN principle. A party may include a narrow MFN clause in an investment treaty to exclude certain investment protections that it grants to a third party.
Imperfect MFN provisions in trade or investment agreements can be a good-faith gesture without giving away all leverage.
Comprehensive MFN
A comprehensive Most-Favored-Nation (MFN) clause is a type of MFN clause that covers a wide scope of obligations. Comprehensive MFN clauses can cover various aspects of trade and investment, including:
- Tariff reductions
- Non-tariff barriers
- Investment protections
- Intellectual property rights
A comprehensive MFN clause requires a party to extend the same treatment to another party as it grants to any third party, with respect to all matters covered by the clause.
Comprehensive MFN clauses are designed to promote fair competition and equal treatment among trading partners, and to prevent countries from engaging in discriminatory practices that could harm other trading partners. By requiring countries to extend the same treatment to all other countries, comprehensive MFN clauses help create a level playing field for global trade and investment.
Why do the types of MFN provisions matter?
MFN provisions with different flavors allow the signing parties to exhibit more or less flexibility, which can be useful to align the language with the signing party’s intentions. The MFN clause is a powerful provision, and it is important that the nations or businesses involved carefully select language that aligns with the spirit of the negotiation, limiting any harmful ramifications that may unfold in the future.
The above types of MFN provisions are basic directions that contractual languages may take in practice. The actual language, and stipulations attached to an MFN clause may be even more specific depending on the contract.
If you or your business are considering entering a trade or investment partnership, an MFN provision in the contractual agreement may be beneficial to offset unfair or discriminatory pricing.
Additional Reading
EU Considering Removing Russia’s MFN Status
Due to recent events, the European Union is considering removing the MFN status of Russia at the World Trade Organization. Read more here:
MFN History
The MFN clause has been a core element of trade; appearing in commercial treaties as far back as the 1600s. Read more about the history of MFN provisions and how they’ve evolved over time.
US Changing MFN Language
The United States has changed how they’ve approached the specific language that drives an MFN clause. From the official report:
In international trade, the term most-favored-nation (MFN) treatment has a meaning at variance with what it appears to mean: the expression means equal — rather than exclusively favorable — treatment and is often used interchangeably with “nondiscriminatory.” To make this distinction clearer and avoid a possibly misleading interpretation of the most-favored-nation term, legislation was enacted in 1998 to replace it in U.S. law with the term “normal trade relations,” or NTR.
Read the full report here:
