BG Group's Implication to the Tax World

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By Peter A. Lowy, Esq.

Caplin & Drysdale, New York, NY

On March 5, 2014, the Supreme Court of the United States
delivered its opinion in BG Group PLC v. Republic of
, a case involving the interpretation of an
international treaty's arbitration provision. While the case does
not involve taxes and arose under a bilateral investment treaty,
the decision is a relevant reference point for drafting and
negotiating dispute resolution provisions in production sharing
contracts for extractive industries such as mining and oil &
gas production, and possibly for international tax conventions that
contain arbitration clauses.

In BG Group, an arbitration panel rendered a $185
million award in favor of BG Group and against the Government of
Argentina. Leading up to BG's claim to arbitrate, Argentina had
changed Argentine law, materially impacting the economics of a deal
BG Group had previously reached for a majority stake in an
Argentine gas distribution company. Claiming, among other things,
that the law change was tantamount to an expropriation, BG Group
filed for arbitration pursuant to the UK-Argentina investment
treaty (Treaty for the Promotion and Protection of Investments,
Art. 8(2), Dec. 11, 1990, 1765 U. N. T. S. 38).

Article 8 of the investment treaty contained a dispute
resolution provision, which provided that a treaty-protected entity
may commence international arbitration proceedings, after the
entity had filed a challenge in local court and 18 months had
elapsed. BG Group, however, filed its arbitration claim
without first pursuing such local litigation. The arbitration panel
determined, against Argentina's objections, that BG Group's failure
to pursue local litigation did not undermine the arbitration
panel's ability to hear and decide the dispute. After the panel
ruled in favor of BG Group, Argentina appealed to the U.S. court

At the Supreme Court, the issue presented was whether a court of
the United States, in reviewing an arbitration award made under the
treaty at issue, should interpret and apply the local litigation
requirement de novo, or with the deference that courts
ordinarily owe arbitration decisions. That is to say, who - court
or arbitrator - bears primary authority for interpreting and
applying the local litigation requirement to an underlying

In its analysis, the Court first confirmed the following
paradigm. On the one hand, courts presume that the parties intend
courts, not arbitrators, to decide disputes known as
"arbitrability." These include questions such as "whether the
parties are bound by a given arbitration clause," or "whether an
arbitration clause in a concededly binding contract applies to a
particular type of controversy." On the other hand, courts presume
that the parties intend arbitrators, not courts, to decide disputes
about the meaning and application of particular procedural
preconditions for the use of arbitration.

This paradigm has a multitude of nuances, and the line between
the two categories is at times quite blurry. The Supreme Court in
this case, in a 7-2 decision, pigeon-holed the local litigation
requirement into the latter category - a procedural precondition.
According to the majority, it is more akin to a claim-processing
requirement than a provision that speaks to the validity or scope
of arbitration, and thus it is for arbitrators, not the courts, to
make the determination.

The Court's decision may be relevant to drafting and negotiating
production sharing contracts and concessions. These agreements are
prevalent in extractive industries such as mining and oil &
gas, when companies are investing in natural resources in countries
with fiscal regimes that are either underdeveloped or ill-fitted to
deal with these types of capital-intensive foreign
investments. Production sharing agreements vary in their
terms about when tax disputes must be litigated in local courts or
before local fiscal administrations, and when they may be presented
to arbitrators under international arbitration rules. When these
provisions are unclear, companies often learn the hard way that the
production sharing contacts should clearly set out the roles and
responsibilities of international arbitrators versus the local
country dispute resolution machinery, specifically in relation to
tax disputes. BG Group provides a relevant reference
point for drafting and negotiating such provisions.

For more information, in the Tax Management Portfolios, see
Cole, Kawano, and Schlaman, 940 T.M.
, U.S. Income Tax Treaties
- U.S. Competent Authority Functions and Procedures.