Anyone still unclear about why the police are constructing a modern-day Bastille around Quebec City in preparation for a forthcoming summit and the unveiling of the Free Trade Area of the Americas should take a look at a case being heard by a Canadian provincial supreme court.

In 1991 a United States waste management company, Metalclad, bought a closed-down toxic treatment facility in Guadalcazar, Mexico. The company wanted to build a huge, hazardous waste dump, and promised to clean up the mess left behind by the previous owners. In the years that followed it expanded operations without seeking local approval, earning little goodwill in Guadalcazar. Residents lost trust that Metalclad was serious about cleaning up, feared continued groundwater contamination, and eventually decided that the foreign company was not welcome.

In 1995, when the landfill was ready to open, the town and state intervened with what legislative powers they had available: the city denied Metalclad a building permit, and the state declared that the area around the site was part of an ecological reserve.

By this point the North American Free Trade Agreement, Nafta, was in full effect, including its controversial chapter 11 clause that allows investors to sue governments. So Metalclad launched a legal challenge, claiming that Mexico was "expropriating" its investment.

The complaint was heard in Washington by a three-member arbitration panel.Metalclad was awarded $16.7m. Using a mechanism allowing an appeal to a third party, Mexico has chosen to challenge the ruling before a Canadian court.

The Metalclad case is a vivid illustration of what critics mean when they allege that free-trade deals amount to a "bill of rights for multinational corporations". Metalclad has successfully played the victim, oppressed by what Nafta calls "intervention" and what used to be called "democracy".

Sometimes democracy breaks out when you least expect it. Maybe it's in a sleepy town,or a complacent city, where residents suddenly decide that their politicians haven't done their jobs, and intervene. Community groups form, council meetings are stormed. And sometimes there is a victory: a hazardous mine never gets built, a plan to privatise the local water system is scuttled, a rubbish dump is blocked. These outbreaks of grassroots intervention are messy, inconvenient and difficult to predict. It is precisely this kind of democracy that the Metalclad panel deemed "arbitrary".

Under so-called free trade, governments are losing their ability to be responsive to constituents, to learn from mistakes and to correct them before it's too late. Metalclad's position is that the federal government should simply have ignored the local objections. There's no doubt that from an investor perspective it's always easier to negotiate with one level of government than with three. The catch is that our democracies don't work that way: issues such as waste disposal cut across levels of government, affecting not just trade but drinking water, health, ecology and tourism.

Furthermore it is in local communities that the real impacts of free-trade policies are felt most acutely. It is cities that are asked to absorb the people pushed off their land by industrial agriculture, or forced to leave their provinces because of cuts in federal employment programmes. It is cities and towns that have to find shelter for those made homeless by deregulated rental markets, and municipalities that have to deal with the mess of failed water privatisation experiments—all with an eroded tax base.

There is a move among many local politicians to demand increased powers in response to this offloading. Citing the Metalclad ruling, Vancouver city council passed a resolution last month petitioning "the federal government to refuse to sign any new trade and investment agreements, such as . . . the Free Trade Area of the Americas, that include investor-state provisions similar to the ones included in Nafta".

Cities and towns need decision-making powers commensurate with their increased responsibilities, or they will be turned into passive dumping grounds for the toxic fallout of free trade. Sometimes, as in Guadalcazar, the dumping is plain to see. Most of the time it is better hidden.

This article first appeared in The Guardian Weekly.