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Pepper Hamilton Client Alert: Supreme Court Holds that Courts Must Defer to Arbitrators in First Case Addressing International Investment Treaty Arbitration

On March 5, 2014, the United States Supreme Court decided BG Group, PLC v. Republic of Argentina, the first case in which the Court addressed an international investment treaty arbitration (a case between a private investor and a sovereign nation). In a 7-2 decision, the Court reversed a prior decision of the United States Court of Appeals for the D.C. Circuit, and reinstated a $185.3 million award against Argentina. The Court held that the D.C. Circuit was not entitled to substitute its judgment for that of the arbitrators as to whether BG Group was required to sue Argentina in Argentinean court prior to filing for arbitration.

The case’s implications go far beyond investment treaty arbitration, as the holdings apply in large part to all arbitrations. In particular, the Court emphasized the deference due to arbitrators and clarified further the distinctions between the role of courts and of arbitrators in deciding when a dispute is arbitrable. This is yet another pro-arbitration opinion handed down by the Supreme Court. Practitioners and clients wanting to enforce their arbitration clauses and avoid court altogether have yet another case from the Supreme Court that they can rely on.

BG Group arose from Argentina’s economic crisis in the early 2000s. BG Group (a United Kingdom firm) was part of a consortium that owned a majority interest in MetroGAS, a company which held a 35-year exclusive license to distribute gas in Buenos Aires. Prior to the economic crisis, Argentina’s regulators were charged with setting gas “tariffs” in U.S. dollars such that MetroGAS (and its owners) would receive a reasonable return on investments. When the economic crisis struck in 2000-01, however, Argentina enacted emergency measures that provided gas tariffs would be calculated in Argentinean pesos. Given the collapse of the peso, “MetroGAS’s profits were quickly transformed to losses.”

BG Group subsequently initiated an arbitration under the U.K.-Argentina Bilateral Investment Treaty (BIT), which covers disputes between U.K. investors in Argentina and the Argentinean government, alleging that Argentina had expropriated BG Group’s investment in MetroGAS by enacting the emergency measures. An arbitral tribunal was convened in Washington, D.C. under the United Nations Commission on International Trade Law (UNCITRAL Rules). Argentina argued that the tribunal lacked jurisdiction because the U.K.-Argentina BIT required BG Group to file a lawsuit in Argentina and await a judgment or the passage of 18 months before it could initiate arbitration (a “local litigation requirement”). In opposition, BG Group argued that compliance with the BIT’s local litigation requirement was excused because, as part of the emergency measures, Argentina had enacted laws that hindered access to Argentina’s courts. Specifically, Argentina suspended all court judgments relating to the emergency measures for 180 days, and more importantly, only permitted utility companies like MetroGAS to renegotiate their contracts with Argentina to the extent those firms (or their owners) did not sue Argentina.

The tribunal sided with BG Group, and excused compliance with the local litigation requirement. On the merits, the tribunal awarded BG Group $185.3 million, in addition to interest, costs and attorneys’ fees.

BG Group moved to confirm the award in the District of Columbia, and its petition was granted by the U.S. District Court. Argentina appealed, and the D.C. Circuit vacated the award. The D.C. Circuit reviewed the arbitrators’ decision regarding the local litigation requirement de novo, and determined that it was a “gateway” requirement that could not be bypassed. Republic of Argentina v. BG Group PLC, 665 F.3d 1363, 1370-71 (D.C. Cir. 2012).

The Supreme Court reversed on a 7-2 vote, holding that the D.C. Circuit erred in reviewing the arbitrators’ jurisdiction decision de novo. The majority concluded that the arbitrators’ decision regarding the BIT’s local litigation requirement was the type of threshold procedural question on which courts routinely defer to arbitrators. The fact that BG Group arose in the context of an investment treaty was ultimately irrelevant.

The Court analyzed the local litigation requirement in the U.K.-Argentina BIT as if the BIT were an ordinary contract. Writing for the majority, Justice Stephen Breyer explained the difference between substantive arbitrability questions and threshold procedural questions about a party’s right to enforce an arbitration agreement:

On the one hand, courts presume that the parties intend courts, not arbitrators, to decide what we have called disputes about “arbitrability.” These include questions such as “whether the parties are bound by a given arbitration clause,” or “whether an arbitration in a concededly binding contract applies to a particular type of controversy.”

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On the other hand, courts presume that parties intend arbitrators, not courts, to decide disputes about the meaning and application of particular procedural preconditions for the use of arbitration.

The court then reviewed the text of the local litigation requirement in the U.K.-Argentina BIT, and determined it fell into the latter category. To the majority, the U.K.-Argentina BIT clearly evidenced an “agreement to arbitrate” between Argentina and any U.K. investor, like BG Group. The local litigation requirement simply “determine[d] when the contractual duty to arbitrate arises, not whether there is a contractual duty to arbitrate at all.”

Having concluded that the local litigation requirement was a procedural issue as a matter of contract, the Court analyzed whether it made any difference that the requirement was set forth in a treaty. The majority concluded it did not. Therefore, the Court was required to show deference to the arbitrators’ underlying decision, and could only review whether the arbitrators exceeded their powers in excusing BG Group’s compliance with the local litigation requirement. Because the arbitrators’ decision was a proper exercise of the panel’s authority, the Court reversed the D.C. Circuit, and reinstated the award.

Chief Justice John Roberts wrote a lengthy dissenting opinion, joined by Justice Anthony Kennedy. Importantly, however, the dissent did not dispute the majority’s articulation of the distinction between questions of substantive arbitrability and threshold procedural questions regarding the enforcement of an agreement to arbitrate. Instead, the dissent argued that investment treaties, like the U.K.-Argentina BIT, must be interpreted differently (“It should come as no surprise that, after starting down the wrong road, the majority ends up in the wrong place.”). In the dissent’s view, the U.K.-Argentina BIT did not evidence an “agreement to arbitrate” but merely Argentina’s offer to arbitrate with a group of U.K. investors. That “offer” could only be accepted if BG Global had complied with the local litigation requirement prior to bringing its arbitration, which it did not.

As the first Supreme Court decision in this area, BG Global’s specific guidance as to the proper interpretation of arbitration clauses in investment treaties is of particular importance to practitioners in this area. More broadly, however, the Court’s further clarification of what constitutes a question of substantive “arbitrability” – whether an arbitration agreement exists that covers the dispute at issue – applies to all arbitrations, whether domestic or international. Here, parties can limit the ability of opposing parties to tie up an otherwise arbitrable dispute in Court by carefully crafting dispute resolution clauses that make clear the extent of an agreement to arbitrate. To this end, the decision in BG Global represents another pro-arbitration decision, with the Supreme Court again confirming that U.S. courts will only interfere with the decisions of arbitrators under limited circumstances.

Matthew H. Adler Frank H. Griffin, IV and Min Choi