Arbitration cannot take place in the absence of an agreement to arbitrate, but it is not always clear which particular disputes were intended by the parties to be heard in arbitration. The oft-vexed question is: Who decides this question of arbitrability—the courts or the arbitrators? The U.S. Court of Appeals for the Second Circuit recently issued a decision that sets out guidance on this issue, at least for parties to lawsuits in federal courts in New York, Connecticut and Vermont.
The Second Circuit case, Werner Schneider v. Thailand, decided Aug. 8, 2012, addressed the issues dealt with by the U.S. Supreme Court in First Options of Chicago v. Kaplan, 514 US 938 (1995)—in particular, how to apply the “clear and unmistakable” standard that determines whether a court or an arbitration panel should determine a question of arbitrability.
“Arbitrability” refers to whether or not arbitrators have the authority to rule on a dispute. This, in turn, depends on whether certain parties have agreed to have certain disputes between them resolved through arbitration. Thus, there is potentially, in any dispute, a question of whether the parties did agree to arbitrate and how the issue should be resolved. But underlying this issue lies the question: If the parties did agree to arbitrate, what did they agree to?
In First Options, the Supreme Court said that the parties could agree to have the issue of whether they agreed to arbitrate dealt with by arbitrators. But the courts—not the arbitrators—have to decide whether they did make such an agreement. Perhaps because there was more than a bit of tautological analysis in the question of whether the parties agreed to have arbitrators decide arbitrability, the Supreme Court imposed a high standard to be met by a party making such an argument: “Courts should not assume that the parties agreed to arbitrate arbitrability unless there is ‘clea[r] and unmistakabl[e]’ evidence that they did so.” First Options at 944, quoting from AT&T Technologies v. Communications Workers, 475 U.S. 643, 649 (1986).
The Supreme Court elaborated on this standard by saying that it should be applied in accordance with “ordinary state-law principles that govern the formation of contracts.” Id. In First Options, the relevant state law required that the court determine whether the parties objectively revealed an intent to submit the arbitrability issue to arbitration. Id. That is, silence or ambiguity by the parties as to who—the courts or the arbitrators—decides whether a dispute should be resolved in arbitration would result in the issue’s being decided in the courts. On the other hand, whether a “merits-related” dispute is arbitrable should be determined through the application of a distinctly different standard—one in which there is a presumption in favor of having the arbitrator resolve the dispute.
The Supreme Court recognized that the question of who should decide arbitrability was “rather arcane” (id. at 945), in part because the parties are not likely to have focused on the question of whether they were authorizing in their agreement the arbitrators to “decide the scope of their own powers.” Id. Thus, the Supreme Court imposed a high barrier to be surmounted before parties are forced to arbitrate a matter of arbitrability that they thought would be determined by a judge.
The Supreme Court later attempted to provide some helpful advice as to when an issue is or is not a “question of arbitrability” for a court to decide. In Howsam v. Dean Witter Reynolds, 537 U.S. 79, 83 (2002), the court said that the phrase should be applicable “…where contracting parties would likely have expected a court to have decided the gateway matter…”—what could be described as an after-the-fact subjective test.
Werner Schneider v. Thailand involved an arbitration proceeding that was brought under a bilateral investment treaty (BIT) between Germany and Thailand. BIT arbitrations present different issues as to the intention of the parties because they are almost never between two parties that actually signed an agreement to arbitrate—or even dealt with one another before the dispute. Rather, BIT proceedings subsist under an international regime created by agreements between two governments—one of them the government of the investor who is the claimant, who played no role in the negotiation of the BIT, and the other the government of the host country (the respondent in the arbitration).
In the Schneider case, the claimant prevailed in arbitration and sought confirmation of the award in the Southern District of New York. The award was issued after the arbitral tribunal had bifurcated the proceedings, dealing separately and initially with the question raised by Thailand as to whether the subject matter of the dispute, a highway project, was an “approved investment” under the arbitration provision of the BIT.
After the tribunal ruled in favor of jurisdiction and awarded damages to the claimant following a separate hearing on the merits, the claimant brought a petition before the district court for confirmation of the award. The district court considered that it was not in the “clear and unmistakable” area of whether the parties had agreed to arbitrate, but rather in the second area demarcated by the Supreme Court in First Options—that of arbitration agreement scope, as to which the law required that the court pay deference to the arbitrators’ determination.
There was thus presented to the Second Circuit the question of whether allowing the arbitrators to determine the issue of “approved investment” was subject to the court’s applying the higher level of scrutiny under the “clear and unmistakable” standard or a matter as to which the arbitrators had deferential leeway to rule.
The Second Circuit Ruling
The Second Circuit abjured use of the distinction between a clear and unmistakable intention of the parties to arbitrate and the scope of what they agreed to arbitrate. Instead, it said:
However, whether the district court properly declined to determine independently whether the tollway project involved “approved investments” does not determine whether that question is one of scope or formation. It turns on whether there was clear and unmistakable evidence of the parties’ intent to commit that question to arbitration. For in the absence of such clear and unmistakable evidence, questions of arbitrability are presumptively resolved by the court, regardless of whether they are related to scope or formation [citations omitted; emphasis added]
The court concluded that “that question”—of whether the project involved “approved investments”—had to be subject to the clear and unmistakable test, regardless of whether it related to scope or formation.
Thus, the Second Circuit expanded the concept of “question of arbitrability” to come close to, if not overlap, the issue of scope of the agreement to arbitrate by in effect requiring that courts address in their assessment the question, “arbitrability of what?” In the Schneider case, the arbitral tribunal went through a two-day evidentiary hearing on the meaning of “approved investments,” the kind of task, it might be said, that the parties would expect arbitrators rather than courts to carry out. If this is so, it could also be said that the Second Circuit’s assigning to the district court the broader task of determining arbitrability is inconsistent with the approach taken by the Supreme Court in the Dean Witter case—that a “question of arbitrability” is to be addressed by a court rather than arbitrators when it involves “the kind of narrow circumstance where contracting parties would likely have expected a court to have decided the gateway matter.” Dean Witter, 537 U.S. at 83.
The Second Circuit recognized that it was telling the parties, the arbitrators and the district court, that they had not gone through the right hoops and that they were, after great expenditure of time and money, faced with an award that had not passed its procedural tests because the claim on which it was based had not been subjected to the proper judicial scrutiny. But the court salvaged the situation, for practical purposes, by saying that it would carry out, at its appellate level, the tests that the district court should have done and apply the clear and unmistakable test itself. It did so, referring to its ruling in a prior case involving a BIT, Republic of Ecuador v. Chevron, 638 F.3d 384, at 392 (2d Cir. 2011), where it had held that the Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL) were broad enough to constitute an expression by the parties of their intention to have questions of arbitrability decided by the arbitrators. Specifically, Article 21 of the UNCITRAL Arbitration Rules provides:
The arbitral tribunal shall have the power to rule on objections that it has no jurisdiction, including any objections with respect to the existence or validity of the arbitration clause or of the separate arbitration agreement.
This may be considered an unmistakable agreement by the parties to allow the arbitrators to determine the issue of arbitrability. Since the UNCITRAL Rules also governed disputes under the BIT in the Schneider case, the Second Circuit held that the stringent test of allowing the arbitral tribunal to determine arbitrability had been passed in this case as well.
What Does This Mean?
For courts and practitioners of the Second Circuit, the interpretation by the court of the “clear and unmistakable” standard cannot be regarded as providing clear guidance in future cases. It may afford more opportunities for parties resisting arbitration to argue before the court, as a preliminary matter, that there are questions as to the dimensions of an agreement to arbitrate that rise to the level of “questions of arbitrability” rather than matters for the arbitrators and that the court should address them before referring the case to the arbitral tribunal.
Moreover, the way will be open for parties to BITs to argue that, even though they have a dispute involving an investment in a country that is a signatory to the BIT, the investment in question runs afoul of local law or definitions that place the matter outside the BIT and that this issue must therefore be dealt with by a court rather than arbitrators. Host countries should be pleased.