You may learn very little you did not already know, about federal arbitrability law or investor-State arbitration, from the Second Circuit’s decision in Republic of Ecuador v. Chevron Corp., 2011 U.S. App. LEXIS 5351 (2d Cir. Mar. 17, 2011)). But the decision so elegantly combines fundamental principles from these separate domains of arbitration jurisprudence that it serves to enrich our appreciation of some basic precepts.

In case you have not subscribed to Arbitration Commentaries or the OGEMID discussion forum before today (for shame), here is a primer on Chevron/Texaco’s travails In Ecuador: Citizen groups from Ecuador sued Chevron in New York federal court for environmental harm from oil drilling and toxic waste disposal. Chevron obtained forum non conveniens dismissal, promising to litigate in Ecuador courts. The Government of Ecuador, allegedly, interfered in the litigation in Ecuador to prejudice Chevron’s defense.

Chevron then started an arbitration against Ecuador under the UNCITRAL Rules as permitted in the bilateral investment treaty (BIT) between Ecuador and the United States. A judgment against Chevron has been entered in the Ecuador litigation, the enforcement of which Chevron resists in the US proceedings.

The Ecuador litigation plaintiffs and Ecuador applied separately to the US District Court in New York to enjoin Chevron from pursuing the BIT action. The District Court denied both motions, and in this Second Circuit decision those denials of a stay are affirmed. This commentary concerns the Second Circuit’s position on the Ecuador Government’s attempt to halt the BIT arbitration.

Ecuador argued that by starting the BIT arbitration, Chevron violated the promise it had made to the District Court, to litigate the merits in Ecuador’s courts, as the basis for forum non conveniens dismissal in the original US case. This promise operated as a waiver and estoppel barring the BIT case, said Ecuador.

But Chevron maintained, and the Second Circuit agreed, that: (1) in the BIT, Ecuador offered to arbitrate under the UNCITRAL Rules, (2) those Rules vest power in the Arbitral Tribunal to resolve objections to the Tribunal’s jurisdiction, including objections to the validity of the arbitration agreement, (3) in BIT cases, the bilateral agreement to arbitrate between investor and State arises when the investor accepts the State’s arbitration offer by filing its case, (4) given this contractual basis for investment arbitration, conduct that allegedly operated as a waiver of, or estoppel against, Chevron’s right to file its BIT case concerned the validity of the arbitration agreement, and (5) both sides having agreed to arbitrate under the UNCITRAL Rules, they had “clearly and unmistakably” agreed to arbitrate arbitrability. As between Ecuador and Chevron, therefore, the issues of waiver and estoppel were for the Tribunal to decide.

In one sense, the latest Chevron-Ecuador decision is simply on old twist on a familiar theme. The arbitration-dodger brings collateral litigation, on the merits or over arbitrability, in the teeth of a broad and prima facie valid arbitration agreement that incorporates rules conferring jurisdictional competence on the arbitrators. The Second Circuit decision reminds us that (1) US case law assigning arbitrability decisions to arbitrators in such circumstances applies in cases arising under the New York Convention and FAA Chapter 2, and including investor-State cases, (2) the fact that conduct affecting the validity of the arbitration agreement occurred in a litigation context (i.e. Chevron’s promises to the US court to litigate in Ecuador courts) creates no special circumstance making the court in which that conduct occurred primarily responsible for deciding arbitrability.

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Whether such cases must be addressed, one-by-one, burdening judges and stalling arbitrations, is a question judicial rule-makers in the US may wish to address seriously and soon. Imagine a path-breaking Local Practice Rule in an arbitrability-preoccupied venue like the Southern District of New York:

“When in the course of a pending arbitration the court is to asked to decide whether the court or the arbitral tribunal should determine in the first instance an objection to the arbitral tribunal’s jurisdiction:

    (1) The application shall be brought on by Order to Show Cause on not more than five days notice unless the Court shall otherwise direct;

    (2) The application shall include the full text of the alleged agreement to arbitrate, and of any rule or provision of law to which reference is made in such agreement concerning the powers of the arbitral tribunal to resolve objections to the tribunal’s jurisdiction; and

    (3) The Court shall rule on the application with due regard for the efficiency of the arbitral process; and

    (4) The Court shall award attorneys’ fees and costs to the prevailing party, unless that party shows good cause why no such award should be made.”

How much did the Supreme Court in Stolt-Nielsen really resolve about arbitral class actions?  No single case can answer that question, but much is to be learned from the US Second Circuit Court of Appeals’ new decision, reaffirming its prior decision issued before Stolt-Nielsen, in In re American Express Merchants’ Litigation, 2011 U.S. App. LEXIS 4507 (2d Cir. Mar. 8, 2011).  Here the Court holds that Stolt-Nielsen does not require any change in the Court’s prior ruling that the class action waiver contained in the arbitration agreement between Amex and it merchants is unenforceable under the FAA, violating public policy because its practical effect was to prevent any subscribing merchant from bringing an antitrust claim against Amex.

The plaintiff merchants proved that the costs for economics consultants were so high, relative to the individual merchant’s alleged damages, and the prospects for recoupment of such expert costs were so uncertain, that no individual merchant could be expected to bear them given the small amount of damages a single merchant might claim. On the basis of this evidence, the Court had concluded prior to Stolt-Nielsen that the Amex class action waiver operated as a prospective waiver of antitrust claims against Amex. The class action waiver was therefore unenforceable, under the contract law doctrine that contracts made in violation of public policy will not be enforced. Said the Court here: “Eradicating the private enforcement component from our antitrust law scheme cannot be what Congress intended when it included strong private enforcement mechanisms and incentives in the antitrust statutes.”

Amex’s arguments that this outcome was barred the rationale of Stolt-Nielsen were rejected. First, said the Court, Stolt-Nielsen concerned interpretation by arbitrators of an arbitration clause that was silent concerning class actions.  Its holding that arbitrators may not rely merely on their own conceptions of public policy to interpret such a “silent” clause, the Court reasoned, is not controlling in a case involving an explicit class action waiver.  Such a clause, the Court held, must face scrutiny under Section 2 of the FAA, i.e., it may be denied enforcement “upon such ground[s] as exist at law or in equity for the revocation of any contract.” Further, Stolt-Nielsen does not hold that public policy is an inappropriate basis for deciding the enforceability of an arbitration clause, but only that public policy may not be used by arbitrators as a means to determine the intent of the parties.  That holding, the Second Circuit states, has no bearing of the powers of courts under FAA Section 2 to find that enforcement of a particular arbitration clause would violate an expressly stated and important public policy like private civil enforcement of the antitrust laws.

Many international followers of Arbitration Commentaries will have recently spent time reading, or reading about, the Judgment of the U.K. Supreme Court in the Dallah v. Pakistan case, where, applying French law (and transnational principles as incorporated therein) to the question of whether a foreign state as a non-signatory was bound by the arbitration agreement signed by a state-created entity, found that the answer to that question depended upon the “common intention” of the foreign state and the party demanding arbitration. (In the event, the Court determined — reviewing the question de novo despite the arbitral tribunal’s partial award confirming its own jurisdiction – that there was no common intention to submit disputes with the foreign state to arbitration, and that the final award granting $20.5 million in damages against the state therefore would be refused enforcement). 

But this post is not so much about Dallah  as it is about transnational convergence and diversgence in the law of arbitrability, as reflected in U.S case law. My text for today is a new decision from the U.S. District Court in Manhattan, holding that the Republic of Iraq, seeking damages relating to the corruption of the infamous U.N. Oil-for-Food Programme, may not compel arbitration, on a third-party beneficiary theory, under the arbitration agreement contained in the contract between the United Nations and BNP Paribas. (Republic of Iraq v. ABB AG, 2011 U.S. Dist. LEXIS 141766 (S.D.N.Y. Mar. 3, 2011)).

 Iraq brought this lawsuit in the federal district court in 2008, and only after two years of litigation did it elect to proceed by arbitration and to file a motion to compel arbitration of its own claims. The arbitration clause in the U.N.-BNP Paribas contract (a contract governing BNP Paribas’s administration of Programme funds) provided for ICC arbitration in terms that led the court to conclude that neither side had manifested any intention for Iraq to be a third-party beneficiary of the arbitration agreement. Thus, the clause provided in pertinent part that arbitration would proceed unless there was amicable settlement “within sixty (60) days of after receipt by one Party of the other Party’s request for such amicable settlement,” and failing such settlement the case would be “referred by either Party to arbitration.” Whereas “Party” was defined in the contract to refer only to the U.N. or to the bank, the Court held that the plain language of the clause conclusively contradicted Iraq’s claim that it was an intended third-party beneficiary of the agreement to arbitrate.

The absence of any mention of third parties generally or Iraq specifically in the contract led the Court to conclude, firstly, that the parties had not agreed to arbitrate over the arbitrability of Iraq’s claims. The could be no “clear and unmistakable evidence” of such an agreement to arbitrate arbitrability where there was no contract between the disputants, no evidence that either signatory intended to arbitrate arbitrability with any third parties, and no evidence that the relationship between the non-signatory and one of the signatories was such that a duty to arbitrate arbitrability with the non-signatory could be inferred from the agreement to arbitrate arbitrability with the signatory.  (In this regard the case serves as a useful reminder that, in some circumstances, such so-called “relational sufficiency,” generally a corporate relationship, plus close connection of the non-party’s claims to the contract, can lead to a conclusion under US law that arbitrability disputes with non-signatories must themselves be arbitrated.)  

Turning then to the issue of substantive arbitrability of Iraq’s claims, the court first noted that this was a question of New York contract law. Under such law, the court found, third-party beneficiary status of a non-party in relation to the contract sought to be enforced depended upon the intention of the parties who had entered into the contract. And whereas the contract in question was the agreement to arbitrate, not the commercial contract in which that agreement was found, it was necessary to look at the intention of the parties to the arbitration agreement with respect to the arbitration agreement itself. Citing New York decisions that denied third parties the right to compel arbitration even where it was clear that they were intended beneficiaries of commercial terms of the contract, the court found the language of this arbitration clause, notably its use of the defined term “Party,” contradicted in clear terms any suggestion that any third party would have the right to invoke the agreement to arbitrate.

By deciding the case on these terms, the court’s decision did not need to address, and indeed barely alluded to, the issue of whether the true third-party beneficiary of the Oil-for-Food Programme was the Republic of Iraq, or instead the citizens of the Iraqi State.

Ultimately the instrumental test for deciding the arbitrability of claims with a non-signatory is the same in Republic of Iraq as it was in Dallah: the common intention of the parties as objectively manifested in the words of the agreement. The route to this conclusion was more circuitous for the Dallah court.  As it was a UK court asked to refuse enforcement in the UK of an award made by an arbitral tribunal that had its seat in France, the Dallah court first had to determine what was meant by the language of the New York Convention and the 1996 UK Arbitration Act permitting refusal of enforcement if the arbitration agreement had been invalid under law of place where the award was made.  Ultimately the UK Supreme Court accepted the agreed position of both parties experts’ that while the Convention and the Arbitration Act certainly required reference to French law as the law of the seat, this did not mean domestic French contract law or arbitration law, but rather transnational principles regarding the enforceability of arbitration agreements that have been incorporated into the French law of arbitrability by French courts and commentators.   But the essential principle French law principle so stated, and applied by the UK Supreme Court, was that of the “common intention of the parties” as objectively manifested in their words and actions.  The federal district court in Republic of Iraq, using New York contract law, arrived at the same destination, and certainly with less expenditure of analytical fuel.       

In another respect however, the Dallah and Republic of Iraq cases show wide divergence between US and UK/Continental arbitration law and practice – over the matter of agreements to arbitrate arbitrability.  Each of the decisions cites the US Supreme Court’s decision in First Options v. Kaplan, and its now-talismanic formula of “clear and unmistakable evidence.”   But Dallah provides observers of American law with a useful reminder that the “clear and unmistakable evidence” formula, in its inception in First Options, was a test to determine what would be the scope of judicial review of an arbitrator’s decision that a claim was arbitrable. The Dallah court (in the lead opinion of Lord Mance) uses First Options in precisely that way, to support the conclusion that UK courts, when asked to enforce an award, would review the arbitral tribunal’s determination that it had jurisdiction de novo (“independently” in the word of Justice Breyer, repeated by Lord Mance) unless the parties had clearly agreed to arbitrate over jurisdiction, in which case the jurisdiction award should be treated like any other merits determination by the tribunal.  But in US jurisprudence, the First Options formula has become a gateway formula, used by courts to decide whether to refer arbitrability issues to an arbitral tribunal – a tribunal that, if it has even been constituted, has not yet addressed the arbitrability issue.

That this has happened in the US is a byproduct of a litigation system that, even 86 years after the Federal Arbitration Act, has residual vestiges of hostility toward arbitration. Parties who have signed arbitration agreements routinely bring their claims in litigation despite the arbitration clause, seeking the advantages in court of broader discovery and appeal rights. These usually face, or at least believe they face, no adverse consequences other than dismissal/stay if a motion to compel arbitration succeeds.  (However there is momentum behind the view that even where arbitrability was questioned in good faith, a judicial determination that the claims are arbitrable might lead to an award of damages by the arbitral tribunal for breach of the arbitration clause.) And parties named as Respondents in commenced arbitration proceedings have no compunction to respond by filing collateral litigation over the same claims or some subgroup of the claims in the arbitration that, they assert, are outside the scope of the arbitration agreement.  If there are any court rules or statutes in the United States that require courts to dismiss such suits immediately upon presentation of a prima facie valid arbitration agreement between some parties and governing some disputes, I am not aware of them. As a result, pre-arbitration litigation over arbitrability is a cottage industry for lawyers in the United States, and a major obstacle to the efficiency of arbitral dispute resolution here. In contrast, both the UK and French systems, by statute, push a far wider swath of initial arbitrability decisions to the arbitrators, as is noted by Lord Collins in his concurring opinion in Dallah. French law apparently requires dismissal of litigation if a prima facie valid arbitration agreement may govern the dispute – something roughly equivalent to the ICC’s Article 6 (2) prima facie threshold for launching a case.  The UK Act requires the arbitrability decision to be made by arbitrators unless both parties agree to have a judicial determination, or unless the arbitrators themselves ask the court to decide.

These are the fundamental differences that have prompted some American international arbitration practitioners to remark that “compétence-compétence” as it is known in Europe is essentially non-existent in the United States. And until courts and legislatures in the United States come to grips with this issue, litigation over arbitrability will continue to be an aspect of international arbitration in the United States that fosters an unfavorable image for US venues as potential seats of international arbitrations.

A commentary on the US Second Circuit Court of Appeals’s recent denial of panel rehearing in the Kiobel case appears on my general website, www.lexmarc.us.  This three-judge Second Circuit panel held in 2010 that the US Alien Tort Statute does not provide for causes of action against corporations, on the grounds that corporate liability for international human rights violations has not achieved the status of a generally-accepted principle of customary international law.

n  Breaking no new ground, but adding rich fertilizer to the garden of  US compétence-compétence jurisprudence, a recent decision by the Chief Judge of the U.S. District Court in Manhattan, nominally applying New York contract law but with the substantial influence of federal arbitral “common law,” held that the arbitrator, not a court, should decide whether particular disputes are within the scope of an admittedly valid arbitration clause, when (1) the language of the clause is very broad, encompassing “any and all disputes” or “any controversy” or similar language, and (2) the parties have agreed to arbitrate under rules that empower arbitrators to resolve issues of their own jurisdiction. Indeed the opinion suggest that either (1) or (2) is probably sufficient as “clear and unmistakable evidence” of the parties’ intent to have arbitral determination of arbitrability issues involving the scope of arbitrable disputes under an admittedly valid clause.  (Rafferty v. Xinhua Finance Ltd., 2011 U.S. Dist. LEXIS 9628 (S.D.N.Y. Jan. 31, 2011).

n  Usefully reminding arbitration lawyers that the “public policy” defense to award enforcement under New York Convention occupies a very narrow plot, a U.S. district judge in Manhattan rejected the position that an award enforcing a contract that allegedly violated U.S. economic sanctions against Iran should be refused enforcement.  While the Iran sanctions certainly reflected U.S. foreign policy, the court stated, this was a far cry from the “’[United States’] basic notions of morality and justice.’” (Ameropa AG v. Havi Ocean Co., 2011 U.S. Dist. LEXIS 15803 (S.D.N.Y. Feb. 16, 2011, quoting from the landmark case of U.S. jurisprudence on the “public policy” defense, Parsons & Whittemore Overseas Co. v. Sociéte Générale De L’Industrie Du Papier, 508 F.2d 969 (2d Cir. 1974)).  

n  U.S. lawyers invoking the New York Convention for any purpose generally consider that the grass is greener in the federal courtyard, and seek removal of cases filed in the courts of the 50 individual states.  The scope of the removal provision for Convention cases, Section 205 of the Federal Arbitration Act, is therefore a matter of considerable interest for U.S. lawyers while it often strikes foreign practitioners as rather arcane.  Section 205 provides that an action or proceeding in a state court may be removed to federal district court if it “relates to” an agreement or award falling under the Convention.  “Relates to” has been construed broadly to encompass any case in which the outcome is conceivably affected by a Convention agreement or award. But the US Ninth Circuit Court of Appeals decision in Infuturia Global Ltd. v. Sequus Pharmaceuticals, Inc., 2011 U.S. App. LEXIS 2337 (9^th Cir. Feb. 7, 2011) takes this broad construction a step beyond where it has gone before.   The defendant in a California state court tortious interference pharma licensing case invoked removal under Section 205 in order to have the federal district court decide the merits of the dispute by holding that a prior arbitration award collaterally estopped the plaintiff. Defendant did not remove for the purpose of seeking recognition or enforcement of either the arbitration award or an arbitration agreement. The plaintiff’s claim was admittedly not arbitrable.  Had removal been sought under the general removal statute, there would have been remand to the state court, because the presence of foreign entities on both sides at the time of removal would have defeated diversity jurisdiction.  But the Ninth Circuit, agreeing with a district court judge in San Francisco, held that removal was proper under Section 205 notwithstanding, and that the voluntary dismissal thereafter of the claims against the non-diverse foreign defendant created diversity jurisdiction that enabled the district court to adjudicate the merits and to dismiss the plaintiff’s claim based on the collateral estoppel effect of the prior Convention award.   Is this a correct interpretation?  I am not entirely convinced.  Should not the term “relates to” in Section 205 be construed in light of the overall purpose of Chapter Two of the FAA, stated in Section 201, to “implement [the New York Convention] in accordance with this Chapter”?  The Convention is concerned with the enforcement of arbitration agreements and the recognition and enforcement of awards. It does not speak directly to the preclusive effect of a Convention award in proceedings involving one or more parties who are not bound by the same contract and the same arbitration clause. The Convention leaves the res judicata and collateral estoppel effect of arbitral awards, and judgments entered upon such awards, to the law of the State where the award or judgment is relied upon.   The Convention deals with the risk that a Member State’s courts might fail to give proper preclusive effect to a Convention award by ensuring that the award may be converted into a domestic judgment, whereupon no court could lawfully discriminate in applying claim preclusion rules between that judgment and any other judgment.  Perhaps the Ninth Circuit has taken broad construction of broad statutory language one step too far.

In a variation on the theme of Hall Street Associates v. Mattel, Inc., the US Ninth Circuit Court of Appeals held in a recent case that the Federal Arbitration Act forbids an agreement of the parties to bypass initial judicial review of the award by a federal district court in favor of first instance review in the Court of Appeals.  (Johnson v. Wells Fargo Home Mortgage, Inc., 2011 U.S. App. LEXIS 2908 (9^th Cir. Feb. 15, 2011).

The parties in Johnson made their agreement to arbitrate in the later stages of a prolonged federal lawsuit alleging unfair credit practices by the Wells Fargo Bank. The agreement, so-ordered as a stipulation by the district court in which the case was pending, provided for “binding arbitration with appeal rights” to which the Federal Arbitration Act would apply.  When Plaintiff asked the district court to confirm the award, and Wells Fargo cross-moved to vacate the award, the district court interpreted the agreement of the parties to require “rubber stamp” confirmation of the award. While the district court as a formal matter did confirm the award and deny the motion to vacate (so that the matter was properly before the Court of Appeals from a jurisdiction perspective), the district court entered judgment without having considered the merits of the motion to vacate, and thus as a practical matter initial judicial review of the award was lodged in to the Ninth Circuit by the district court’s interpretation of the parties’ agreement.

The Ninth Circuit panel disagreed with the district court’s interpretation of the agreement – as did Wells Fargo, which had asked the district court to hear the merits of its motion to vacate. But the Ninth Circuit did not rest its decision on the premise that the district court misinterpreted the agreement, but rather on the ground that the structure of judicial review of arbitration awards prescribed by the Federal Arbitration Act may not be overridden by private agreement. The FAA in Section 9 provides, the Court observed, that the district court shall confirm an award unless it is vacated on a ground provided in Section 10 of the Act, and this implies not only that confirmation must be sought initially in the district court but also that the district court must decide on the merits any motion to vacate that is interposed in response to the prevailing party’s motion to confirm the award.     

The Court did also refer to the possibility – which had been mentioned by the Supreme Court in Hall Street – that the parties might agree to some form of arbitration in a federal district court case management order that provides for entry of judgment by the district court in accordance with the arbitrator’s decision. But the Court found that this was not the sort of court-annexed arbitration the parties had selected; instead they had expressly subjected their arbitration to the FAA and had not opted for a form of quasi-arbitration more akin to proceedings before a court-appointed special master.