Who Decides Arbitrability? A Resurgence of the Debate in the United States

Recently, in a very high-profile decision, the US Court of Appeals for the DC Circuit in Republic of Argentina v BG Group PLC¹ annulled a $185 million arbitration award on the basis of its independent review of the arbitrators’ decision on the arbitrability of the dispute. Once again, this case has brought the question of ‘who decides arbitrability’ to the forefront in the United States. BG Group not only raises questions about the proper allocation of authority between judge and arbitrator, it also underscores the implications of judicial overreaching on the success of international arbitration, particularly in the enforcement context. Not surprisingly, BG Group has generated much concern over the role of courts in arbitration in the United States and, for some, has called into question the principle of finality on which parties seeking to enforce non-domestic arbitral awards in the United States rely.

We consider in this article whether the concerns over BG Group are justified. We begin by reviewing the line of Supreme Court cases on which BG Group relied, all of which took place in the context of domestic arbitration. Next, we examine the holding of BG Group in detail. We follow this with a discussion of a recent Second Circuit decision, Schneider AG v Kingdom of Thailand.² Like BG Group, that case addresses the issue of ‘who decides arbitrability’ in the enforcement context, although it appears to go a step further than BG Group in addressing arbitrator authority. Finally, we consider whether the concern prompted by BG Group about the enforcement of international arbitration awards in the United States is justified.

US Supreme Court jurisprudence and questions of arbitrability

In the 1986 case of AT&T Technologies, Inc v Communications Workers³, the Supreme Court first articulated the now frequently-quoted rule that ‘[u]nless the parties clearly and unmistakably provide otherwise, the question of whether the parties agreed to arbitration is to be decided by the court, not the arbitrator’. Then, in 1995, the Supreme Court decided First Options of Chicago, Inc v Kaplan,⁴ which established the standard to be used by district courts reviewing arbitrator decisions on arbitrability. While AT&T Technologies was decided in the context of a motion to compel arbitration, First Options involved a motion to vacate an arbitration award and a competing request to confirm the award under the Federal Arbitration Act (the FAA).⁵

The parties seeking to vacate the award in First Options had objected to the tribunal’s jurisdiction on the basis that their dispute was not arbitrable, because they were not parties to the arbitration clause in question.⁶ The tribunal rejected this argument and ruled on the merits in favour of the claimant.⁷ The District Court in First Options confirmed the award, a decision that was subsequently reversed by the Third Circuit on the ground that the dispute was not arbitrable.⁸ The Supreme Court granted certiorari to determine the standard of review to be used by a federal court ‘in reviewing the arbitrators’ decision on arbitrability’.⁹

Starting from the premise that ‘arbitration is simply a matter of contract between the parties; it is a way to resolve those disputes - but only those disputes - that the parties have agreed to submit to arbitration’, the Supreme Court determined that the question of ‘who has the primary power to decide arbitrability’ turns upon what the parties agreed about that matter’.¹⁰ Hence, if the parties agreed to submit the matter of arbitrability to the arbitrator, then a reviewing court ‘should give considerable leeway to the arbitrator...¹¹ However, the Court added that ‘[c]ourts should not assume that the parties agreed to arbitrate arbitrability unless there is clear and unmistakable evidence that they did so’.¹² If, however, the parties ‘did not agree to submit the arbitrability question itself to arbitration, then the district court should decide the question... independently’.¹³ On the basis of these principles, the Court concluded that the party seeking confirmation of the award was unable to show that the opposing party had agreed that an arbitrator would decide whether their dispute was arbitrable.¹⁴

At first blush, the rule articulated by the Supreme Court in First Options may appear to be straightforward: arbitrability should be decided by a judge unless the parties clearly agree otherwise. However, just what constitutes a ‘question of arbitrability’ to be presumptively decided by a judge? As BG Group demonstrates, this question has turned out to be far more complicated than first meets the eye.

The Supreme Court considered the question in John Wiley & Sons, Inc v Livingston,¹⁵ a case in which an employer objected to a motion to compel arbitration under a collective bargaining agreement. The employer argued that the employee had not complied with grievance procedures that were prerequisites to arbitration.¹⁶ According to the employer, such ‘procedural’ questions of arbitrability were to be decided by courts, not arbitrators.¹⁷ In evaluating this argument, the Court adopted a bright line approach to determining whether a court or an arbitrator should decide the ‘gateway issue’ of arbitrability. Substantive questions of arbitrability, the Court stated, were to be decided by the courts.¹⁸ Conversely, ‘“procedural” questions which grow out of the dispute and bear on its final disposition should be left to the arbitrator’.¹⁹ In this case, ‘[d]oubt whether grievance procedures or some part of them apply to a particular dispute, whether such procedures have been followed or excused, or whether the unexcused failure to follow them avoids the duty to arbitrate cannot ordinarily be answered without consideration of the merits of the dispute which is presented for arbitration’.²⁰ Hence, whether or not the ‘procedural prerequisites’ involving the grievance procedures had been followed was a procedural question ‘grow[ing] out of the dispute’ to be decided by the arbitrator.²¹ Beyond this analysis, the Court provided little guidance on what types of ‘procedural questions’ ‘grow out of a dispute’ that can be decided by arbitrators.

In Howsam v Dean Witter Reynolds, Inc,²² the Court was presented with the question of whether an applicable statute of limitations provision rendered an arbitration claim falling outside of the limitations period non-arbitrable. On these grounds, the party opposing arbitration, Dean Witter, had sought an injunction in the district court seeking to prevent the party that initiated arbitration, Howsam, from proceeding in the arbitration.²³ In addressing whether the applicability of the statute of limitations to the arbitration was itself a question of arbitrability, the Court observed that while any ‘gateway question’ could potentially constitute a question of arbitrability, for purposes of determining who was to decide a question of arbitrability, the concept had a ‘far more limited scope’.²⁴ A ‘question of arbitrability’ in this context existed only in the kind of narrow circumstances where contracting parties would likely have expected a court to have decided the gateway matter, where they are not likely to have thought that they had agreed that an arbitrator would do so and, consequently, where reference of the gateway dispute to the court avoids the risk of forcing parties to arbitrate a matter that they may well not have agreed to arbitrate.²⁵

On the basis of this analysis, the Court determined that issues involving fulfilment of a condition precedent to arbitration, or waiver, or a ‘like defense’, were ‘procedural questions which grow out of the dispute and bear on its final disposition’.²⁶ Such procedural questions did not constitute ‘question[s] of arbitrability’ to be presumptively decided by a court absent clear and unmistakable evidence that the parties had agreed to submit such questions to an arbitrator.²⁷ By contrast, questions such as ‘whether the parties are bound by a given arbitration clause’ or ‘a disagreement about whether an arbitration clause in a concededly binding contract applies to a particular type of controversy’ were questions of arbitrability to be presumptively decided by a court.²⁸ On the basis of this distinction, the Court held that the statute of limitations claim raised by Dean Witter was a procedural matter to be decided by the arbitrator.²⁹

BG Group v Argentina

Fast-forwarding nearly a decade to January 2012, when BG Group was decided, it is clear that the rules established by the Supreme Court in AT&T Technologies, First Options, John Wiley and Howsam may have provided more questions than answers.

In BG Group, the DC Circuit set aside a $185 million UNCITRAL award rendered in favour of BG Group.³⁰ BG Group had initiated arbitration under the UNCITRAL rules pursuant to a bilateral investment treaty between the United Kingdom and Argentina (the UK-Argentina Treaty). The UK-Argentina Treaty provided that investors were required to submit disputes with the host state to the courts of the host state. If, however, the domestic courts failed to render a final decision within a period of 18 months, either party would have the option to submit the dispute to arbitration.³¹ For various reasons, BG Group determined not to submit its dispute with Argentina to the Argentine courts and directly initiated arbitration.³²

The tribunal found that it had jurisdiction over the dispute, in spite of BG Group’s failure to comply with the UK-Argentina Treaty’s requirement first to submit disputes to the Argentine courts.³³ It determined that the conditions in Argentina at the time of the dispute were such that compliance with the local remedies requirement of the UK-Argentina Treaty would have been futile.³⁴ It proceeded to decide on the merits in favour of certain of BG Group’s claims and to issue an award in favour of BG Group.³⁵

Thereafter, Argentina petitioned to vacate or modify the award pursuant to the FAA, while BG Group cross-moved for recognition and enforcement of the award.³⁶ The district court denied the motion to vacate and granted enforcement in a decision which Argentina appealed to the DC Circuit.³⁷

The DC Circuit determined that the threshold question presented by Argentina’s appeal was ‘arbitrability: when the United Kingdom and Argentina executed the Treaty, did they, as contracting parties, intend that an investor under the Treaty could seek arbitration without first fulfilling... [the] requirement that recourse initially be sought in [Argentina]?’³⁸ In determining whether the local remedies exhaustion requirement was a question of arbitrability, the court employed Howsam’s test of whether the case fit the ‘narrow circumstances’ where the ‘contracting parties would likely have expected a court to have decided the gateway matter.’³⁹ The Court determined that the ‘Treaty provides a prime example of a situation where “the parties would likely have expected a court” to decide arbitrability’.⁴⁰ Then, to determine the proper standard of review of the tribunal’s decision, the DC Circuit considered whether there was ‘clear and unmistakable evidence’ that the parties agreed to submit this question of arbitrability to the arbitrator. Under First Options, if there was such clear and unmistakable evidence, then the tribunal’s decision on this question of arbitrability was entitled to ‘considerable leeway’; if not, then the district court should have decided the arbitrability question independently.⁴¹

The Court then proceeded to conduct its own review of the evidence to determine whether there was ‘clear and unmistakable evidence’ that the parties ‘intended the arbitrator to decide arbitrability where BG Group disregarded the requirements... of the Treaty to initially seek resolution of its dispute with Argentina in an Argentine court’.⁴²

While the court recognised that the UNCITRAL Rules empower a tribunal to determine the issue of arbitrability and that the Treaty allowed for recourse to UNCITRAL arbitration, the Court nevertheless held that Argentina’s consent to grant the arbitrator the power to decide questions of arbitrability under the UNCITRAL Rules was not ‘triggered’ until the BG Group first fulfilled the conditions of the Treaty requiring investors to exhaust local remedies.⁴³ The Court found that the district court, by failing to determine whether the parties had intended to submit to an arbitrator the particular question of arbitrability where the Treaty’s exhaustion requirements had not been fulfilled, erred as a matter of law.⁴⁴

The Court distinguished John Riley on the basis that the substantive/procedural dichotomy adopted by the Court there was drawn to ‘[a]ccord with the policy behind federal labor law’.⁴⁵ Likewise, the Court summarily distinguished Howsam on the basis that the question of arbitrability there was ‘intertwined with the facts underlying the substantive dispute’ and the statute of limitations rule was adopted by the forum in which the arbitration took place, such that the arbitrators were ‘comparatively more expert about the meaning of their own rule’.⁴⁶

Finally, the Court bolstered its conclusion with a discussion of the importance of giving effect to the parties’ agreement, which, in this case, compelled the conclusion that the parties did not intend for an arbitrator to decide the issue of arbitrability where a party failed to comply with the threshold requirement to submit disputes to the local courts.⁴⁷

Schneider AG adds another twist

A recent case issued by the Second Circuit, Schneider AG v Kingdom of Thailand, has added yet another twist to jurisprudence on the ‘who decides’ question. There, the Second Circuit considered the appropriate level of review of a tribunal’s determination that a particular investment fell within the scope of the applicable agreement to arbitrate, contained in a bilateral investment treaty between Germany and Thailand (the Germany-Thailand Treaty).

Over Thailand’s objections, the tribunal in Schneider AG determined that it did have jurisdiction over the claims because the investment was covered by the agreement to arbitrate, and issued an award in favour of the claimant. The investor sought to confirm the award in the United States, while Thailand cross-moved to vacate on grounds that the tribunal lacked jurisdiction for the same reasons it had argued to the tribunal.⁴⁸ The district court held that whether the investment fell within the scope of the Germany-Thailand Treaty was an issue of ‘scope’ and did not concern ‘formation’, and that the tribunal’s decision was accordingly subject to deferential review by the court.⁴⁹

On appeal, the Second Circuit found that, regardless of whether the arbitrability issue was one of scope or formation, the district court erred in failing to determine whether there was clear and unmistakable evidence of the parties’ intent to submit that issue for decision by an arbitrator.⁵⁰ Such an inquiry was required before the district court determined what standard of review to apply to the arbitrator’s decision on arbitrability. The Second Circuit then conducted this analysis itself, finding on a review of the record, that there was ‘clear and unmistakable evidence’ that the parties agreed to grant the arbitrators the power to determine questions of arbitrability, in the form of both the Terms of Reference and the parties’ agreement to use of the UNCITRAL Rules.⁵¹ Accordingly, an independent judicial determination of the arbitrability of the parties’ dispute was unnecessary.⁵²

The test applied by the Second Circuit in Schneider AG seems to skip entirely over the requirement of determining whether a particular issue constitutes a ‘question of arbitrability’ to be presumptively reviewed by a court. Instead, the court directs that, regardless of whether an issue decided by an arbitrator is one of scope or formation, the district court should determine whether there was ‘clear and unmistakable evidence’ that the parties agreed to grant the arbitrator the power to decide the issue. If there is no such evidence, the court may perform an independent review. This holding creates some tension with the premise that certain questions should be left to the arbitrator and reviewed on a deferential basis without any presumption in favour of judicial review. The case thus could expand the ability of US courts to perform an independent review of an arbitrator’s decision.

In addition, the Second Circuit’s approach in Schneider AG serves as a notable counterpoint to that of the DC Circuit in BG Group. Having determined that the consideration of the local remedies requirement should have been decided by a court, the DC Circuit never analysed the BG Group’s substantial arguments that submission to Argentine courts would have been futile. In contrast, once it determined that a court should decide the question of arbitrability, the Second Circuit actually did analyse the underlying question.

Will BG Group prove detrimental to international arbitration in the United States?

BG Group has prompted a flurry of criticism and concern. Schneider AG v Kingdom of Thailand risks engendering similar criticisms, although it is too early to tell at this point, given that the case was decided very recently, in August 2012.

One criticism of BG Group is that it undermines arbitrator authority and impermissibly expands the judicial role in arbitration. This criticism has morphed into a broader concern that BG Group represents a reversal in the United States’ ‘emphatic federal policy in favour of arbitral dispute resolution’ cited in the Mitsubishi case.⁵³ Other concerns relate specifically to the future of enforcement of arbitral awards under the New York Convention. These include the risk that BG Group will encourage parties to take a ‘second bite at the apple’ in challenging arbitration awards, and the converse risk that parties may now hesitate before choosing a United States jurisdiction as the seat of arbitration on account of a lack of confidence prompted by BG Group in the role of US courts in promoting finality of arbitration awards. Yet there are a number of counterarguments that counsel against a hasty conclusion that BG Group is ‘bad’ for international arbitration in the United States.

While BG Group (and now perhaps Schneider AG) can be said to add to the ‘unpredictability’ of enforcement of arbitration awards by expanding the scope of judicial review over ‘questions of arbitrability’,⁵⁴ the better position may be the view of BG Group as just one case in a line of cases where the courts have struggled to draw a line between arbitrator authority and judicial authority. As the review of Supreme Court jurisprudence in this article demonstrates, the Supreme Court has not yet articulated a ‘bright line’ rule for determining the threshold question of what constitutes a ‘question of arbitrability’ to be presumptively decided by a court. Under First Options, that question must be answered before a court may then proceed to determine what standard of review to apply to an arbitrator’s decision on a question of arbitrability. A review of BG Group indicates that the court there lacked guidance in determining that threshold question. It relied primarily on the Supreme Court’s imprecise direction that a court should ask itself whether the parties ‘would likely have expected a court to have decided the gateway matter’.⁵⁵ It is perhaps not surprising that application of this nebulous principle could lead to a seemingly counter-intuitive result. In a similar vein, the ‘procedural/substantive distinction’ discussed in John Wiley and Howsam may, in some cases, be a difficult rule to apply, given the frequent overlap between procedural and substantive issues.

Additionally, outside of the ‘arbitrability’ context, US courts have continued to enforce awards routinely. Applications pursuant to the New York Convention to enforce arbitration awards issued in forums and under rules ranging from the International Centre of Dispute Resolution⁵⁶ to FIFA’s dispute resolution chapter, ⁵⁷ to the Society of Maritime Arbitrators Rules⁵⁸ and to the ICC Rules, have been granted in various district courts this year. The Second Circuit, which decided Schneider AG, also recently issued a ‘pro-enforcement’ decision, Scandinavian Reinsurance Company Limited v Saint Paul Fire and Marine Insurance Company, et al.⁵⁹ In that case, the Second Circuit reversed a decision by the lower federal district court to vacate an arbitration award on account of arbitrator bias. The Second Circuit held that the failure of two co-arbitrators to disclose concurrent service in a similar arbitration, without evidence of bias, did not provide a basis for vacating an arbitral award on ‘evident partiality’ grounds under the New York Convention as implemented by the FAA.⁶⁰ The largely pro-arbitration decisions from US courts should quell some of the concern over the potential effect of BG Group and related decisions such as Schneider AG on the future of international arbitration, and specifically enforcement, in the United States. As US courts continue to deal specifically with arbitration in the international context, there will inevitably be greater certainty for parties seeking to enforce arbitration awards in the United States and increased confidence in the role of the arbitrator. Perhaps at that point we will finally find the elusive ‘perfect’ allocation of authority between judge and arbitrator.

Notes

* The authors are grateful to Sonia Farber and Benjamin Aronson for their excellent assistance in preparing this article.

1. 665 F.3d 1363 (DC Cir 2012).
2. Schneider v Kingdom of Thailand, Docket No. 11-1458-cv, 2012 WL 3194228 (2d Cir 8 August 2012).
3. 475 US 643, 649 (1986).
4. 514 US 938, 944-45 (1995).
5. 9 USC section 1 et seq.
6. AT&T Technologies, 514 US at 941.
7. Id.
8. Id.
9. Id.
10. Id. at 943 (emphasis in original).
11. Id.
12. Id. (internal citation and quotation omitted).
13. Id.
14. Id. at 946-47.
15. 376 US 543 (1964).
16. Id. at 555-56.
17. Id.
18. Id. at 557.
19. Id.
20. Id.
21. Id. at 558-59.
22. 537 US 70 (2002).
23. Id. at 82.
24. Id. at 83.
25. Id. at 83-84.
26. Id. at 84-85.
27. Id.
28. Id.
29. Id. at 85.
30. Republic of Argentina v BG Group PLC, 665 F.3d 1363 (DC Cir 2012).
31. Id. at 1366.
32. Id. at 1367.
33. Id. at 1368.
34. Id. at 1367-68.
35. Id. at 1368.
36. Id. at 1368-69.
37. Id. at 1369.
38. Id.
39. Id. (citing Howsam, 537 US at 83-84).
40. Id. at 1371.
41. Id. at 1370.
42. Id. at 1371-72.
43. Id. at 1370-71.
44. Id. at 1371-72.
45. Id. at 1372-73.
46. Id. at 1372 n.6.
47. Id. at 1373.
48. 2012 WL 3194228, at *1-2.
49. Id. at *2.
50. Id. at *3.
51. Id. at *3-4.
52. Id.
53. Mitsubishi Motors Corp v Soler Chrysler-Plymouth, Inc, 473 US 614, 631 (1985).
54. Jean E Kalicki & Dawn Yamane Hewett, ‘The Unavoidability of Uncertainty: One Lesson from the Recent US Court Ruling in Argentina v BG Group’, Kluwer Arbitration Blog (27 January 2012), http://kluwerarbitrationblog.com/blog/2012/01/27/the-unavoidability-of-uncertainty-one-lesson-from-the-recent-u-s-court-ruling-in-argentina-v-bg-group/ (last visited 17 August 2012).
55. BG Group, 665 F.3d at 1371.
56. Subway Intern BV v Bletas, Slip Copy, Civil Action No. 3:10-cv-01715 (JCH), 2012 WL 1118205 (D Conn 3 April 2012) (confirming application to enforce award issued in International Centre of Dispute Resolution).
57. Chelsea Football Club Ltd v Mutu, Case No. 10-24028-CIV, 2012 WL 463932 (SD Fla 13 February 2012) (confirming award issued by FIFA’s dispute resolution chapter).
58. Sea Shipping Inc v Half Moon Shipping LLC, No. 11 Civ 8152(PAE), 2012 WL 245204 (SDNY 26 January 26 2012) (confirming arbitration award issued under Society of Maritime Arbitrators Rules).
59. No. 10-0910-cv, 668 F.3d 60 (2d Cir 3 February 2012).
60. Id. at 74.