Authors: Georg Scherpf*, Antonios Politis**, and Benedikt Kaneko***
| Jurisdictions: | Topics: |
Introduction
For cross-border projects and global business relationships, arbitration is understood as resolving disputes once and for “all.” The finality may often be a given, but is the dispute also resolved for “all”? Particularly in major construction projects or corporate transactions with many actors involved, the usual bilateral setup of arbitral proceedings may fail to do justice to the need for a one-stop dispute resolution process. Instead, endless recourse proceedings with uncertain outcomes can be the result. In the following post, we look at how the German procedural law concept of third-party notices [Streitverkündung] may be adopted in international arbitration to increase the efficiency of dispute resolution beyond its current limits.
Following a complex dispute involving multiple parties across several layers of contractual relationships, the sued parties often commence actions against their own contractual partners down the vertical supply chain, such as subcontractors. As a result, lengthy and expensive recourse proceedings will arise, where almost identical facts (e.g., the existence of defects) are argued all over again. Not just unnecessarily costly and burdensome, such suits may pose a significant risk of contradictory rulings. For example, despite the common use of warranties and indemnification clauses in back-to-back contracts (e.g., based on the FIDIC Yellow Book Subcontract in construction cases), different tribunals may arrive at different results. The parties may consequently lose recourse claims, like those against subcontractors.
A possible remedy to this risk of “losing twice” lies in the procedural instrument of third-party notices. Resembling common-law instruments such as impleader and vouching-in, the mechanism of third-party notices is provided by Sections 72 et seq. of the German Code of Civil Procedure [Zivilprozessordnung, or “ZPO”]. By creating a binding effect for recourse proceedings, third-party notices prevent contradictory rulings and potentially stop statutory or contractual time bars from running, thereby increasing the efficiency of dispute resolution in complex multiparty projects. This post will investigate how this mechanism may be applied in the context of international arbitration, in hopes for a broader debate in the arbitral community outside of Germany.
Third-Party Notice under German Procedural Law
Third-party notice based on the ZPO is a popular tool whenever multiparty contracts are being litigated before German state courts: not only does it allow for the participation of non-parties during pending proceedings, but it also creates a binding effect for recourse proceedings.
Third-party participation in ongoing proceedings as interveners
Usually, a third-party notice is commenced by a party that anticipates an unfavorable outcome in pending proceedings and hopes to bring a recourse claim (e.g., a claim for warranty or indemnification) against a third party (e.g., a subcontractor or supplier). Such a party can submit a request to the court for leave to serve notice on a specific third party. As a positive side effect, any statute of limitation regarding recourse claims will be suspended by law. The third party can then decide whether it wishes to join the ongoing proceedings as an “intervener” [Nebenintervenient or Streithelfer] in support of one of the main parties.
If the third party under notice refuses to join the proceedings as an intervener, the litigation will proceed without it. By contrast, if the third party joins the proceedings as an intervener, it will directly participate in the proceedings with certain albeit limited rights, including the right to make procedural applications, submit briefs (including evidence), raise defenses, and even issue “follow-on-notices” [Weiterverkündung] to other third parties (such as sub-subcontractors). Some of the aforementioned rights may only be exercised if they do not contradict the procedural declarations and actions of the supported main party (Section 67 of ZPO). The third party, in turn, cannot be the addressee of any obligation under the resulting judgment, because of its procedural position as an intervener and not a “full” party—which distinguishes it from a “joinder” [Streitgenossenschaft] in arbitration.
Binding “intervention effect” in recourse proceedings
The main advantage of third-party notices lies not in the pending “primary proceedings” but in (potential) subsequent proceedings against the third-party notice recipient. In such “recourse proceedings,” the notice recipient is bound by the findings of the primary proceedings—regardless of whether it joined them as an intervener. This “intervention effect” [Interventionswirkung] prevents contradictory rulings on the same subject matter. Notably, the third-party notice recipient cannot later argue (with certain exceptions) that the previous dispute has been incorrectly resolved, as it either was involved as an intervener or has forfeited its opportunity to participate in the primary proceedings altogether (see Sections 74(3), 68 of ZPO). Naturally, this creates a strong incentive for the third party to join the primary proceedings in the first place.
Can Third-Party Notice be Transposed to Arbitration?
Through the intervention effect, the instrument of third-party notice contributes to efficiency in dispute resolution among multiple parties and across multiple contractual relationships in German state courts or other jurisdictions. This impactful mechanism can also be used in arbitration by including respective provisions in the arbitration agreement. Today, it is already increasingly popular in multiparty situations, e.g., in complex projects relating to infrastructure, construction, and energy investments, but also in share purchase agreements. The contractual setup usually requires all potential recipients of third-party notices to sign the same arbitration agreement and to agree on contractual stipulations transposing the third-party notice mechanism (particularly interveners’ procedural rights) to arbitral proceedings.
However, current institutional arbitration rules cannot fully accommodate the involvement of non-parties with specific procedural rights because almost none of the major institutions have provided explicit rules regarding third-party notices in their arbitration rules or model arbitration clauses. Only the 2021 Swiss Rules of International Arbitration, in Article 6(4), include a rather vague opener for third-party participation “in a capacity other than as an additional party.” This would allow non-parties to participate in arbitral proceedings with limited procedural rights, but it ultimately leaves it to the tribunal to decide on the “modalities” of such participation. Upon search, there appears to be no evidence of the actual use of Article 6(4) in this context of third-party intervention.
Indeed, in arbitration, procedural participation by non-party interveners is usually not foreseen by institutional rules. To participate, third parties would therefore either become full parties by way of joinder or consolidation, or participate as non-parties without any actual procedural rights (e.g., by submitting amicus curiae briefs). In cases where the procedural participation of interveners is expressly agreed upon, there remains a high risk of conflict or even incompatibility with institutional rules. In our experience, institutions and tribunals seem to struggle with the possibility of intervener participation and will often try to adapt the rules applicable to the regular joinder to them. In any case, arbitrators will have to make sometimes difficult ad hoc decisions on the procedural rights and obligations of interveners.
This issue has also been identified by German legal practitioners and scholars, which is why several initiatives have already emerged in Germany that develop rules to mitigate any potential incompatibilities:
1). From the perspective of arbitral institutions, the German Arbitration Institute (DIS) has set up a working group to look into the possibility of incorporating these procedural instruments into its arbitration rules and, to this end, has on 2 May 2023 published a final draft on “Supplementary Rules for Third-party Notices” [Ergänzende Regeln für Streitverkündungen, or “DIS-ERS”]. Once finalized, these rules are meant to adapt the main features of the third-party notice mechanism under German procedural law for arbitrations under the DIS Arbitration Rules. Under the DIS-ERS, a third-party notice recipient will be bound by the findings of the primary proceedings for recourse proceedings [Folgerechtsstreit] (see Article 11.2 of DIS-ERS)—regardless of whether these are a DIS-arbitration or an arbitration at all—and will have similar rights as a third-party notice recipient in German state court proceedings (Article 6.4 of DIS-ERS). Furthermore, the DIS-ERS specifically address particularities of arbitration and their compatibility with participation by interveners (for example, the selection of arbitrators, rules on confidentiality, etc.). Applying these rules will depend on the consent of all involved parties, including the third party or the prospective recipient of the third-party notice. Interestingly, such consent (particularly regarding the binding effect for recourse proceedings) can also be given without any agreement on a uniform DIS-clause between all parties, for which the DIS-ERS provide a so-called “Alternative Model Clause.” The DIS-ERS are expected to be finalized and published later this year. Whether arbitrations based on the DIS-ERS will render binding awards for the intervening party remains to be seen.
2). Furthermore, a group of German practitioners led by Dr. Karl J.T. Wach has drafted the “Munich Rules on the Participation of Third Parties in Arbitration Proceedings” (“Munich Rules”), which aims to incorporate the third-party notice mechanism by an additional agreement between the parties—i.e., with no need to refer to a specific set of institutional rules. These rules, which shall apply “in addition to and taking precedence over” any chosen arbitration rules or arbitration agreements, mainly address the admissibility (§ 2) and formal requirements (§ 3) of third-party notices as well as the legal position of the third party in the pending proceedings (§§ 5.1–2). In contrast to the DIS-ERS, joining as an intervener or declining to join is not directly linked to any consequences as, according to § 5.3 of the Munich Rules, “[t]he legal consequences of the joinder or the failure to join the proceeding shall be governed by the applicable substantive law.” Therefore, any intervention effect depends on the recourse relationship connecting the issuer of the third-party notice and its recipient. However, only if the recourse relationship is contractual (e.g., a subcontractor contract), there usually is room to agree on specific consequences. An intervention effect is only triggered if and to the degree agreed upon in the recourse relationship. This, however, will not always be the case (e.g., if the recourse relationship is solely based on tort claims), which is why the above-mentioned “incentive” for a third party to join the primary proceedings will be somewhat limited.
Both approaches are new and still need to be tested in practice regarding compatibility with institutional rules and enforceability—particularly regarding the acceptance of the intervention effect in subsequent proceedings. However, once included in institutional rules, these and similar rules could lead to a more efficient resolution of multiparty contract disputes.
Key Issues to Consider When Including a Third-Party Notice Mechanism in Arbitration Agreements
Until the DIS-ERS and the Munich Rules are tried and tested, it is necessary to draft bespoke arbitration agreements which cover not only the participation of third parties in ongoing proceedings along with the intervention effect but also the compatibility with specific institutional rules, if chosen. When opting for such an “intervention agreement,” contractual parties should consider, among others, several key points:
Creating a binding effect across multiple contractual relationships
First, it is advisable to have all involved parties across all contractual levels—i.e., including prospective addressees of recourse claims—sign a single arbitration agreement containing the third-party notice mechanism regulating the intervention effect. This “intervention agreement” should be concluded separately from the respective contractual relationships and drafted as a stand-alone agreement conclusively regulating all aspects of third-party notices (and follow-on notices) and their consequences for the primary and recourse proceedings.
As a result of such an agreement, all parties can be certain that any ruling on a specific matter can have a binding effect on any recourse proceedings if a third-party notice is issued. Therefore, the incentive will be high to participate in the proceedings leading to the ruling and resolve the dispute as far as possible as a “One Stop Shop,” or at least in truncated and expeditious recourse proceedings with the facts already established. If, however, no such intervention agreement is in place and all contractual relationships include individual (and therefore possibly contradicting) dispute resolution clauses, there is a high risk that the intervention effect will be challenged in each subsequent proceeding and ultimately invalidated.
Appointing the Tribunal
Equally important is a clear mechanism for the appointment of arbitrators where non-party interveners are involved: Since a third-party notice recipient has an interest in the arbitration due to the resulting intervention effect, it is important to establish a mechanism that balances the interests of all participants to the arbitration and that ensures the enforceability of the award, particularly given the “equality of parties in the appointment of arbitrators” as set out in the Dutco-decision. One option is to give all participants (including interveners) a say in arbitrator selection and to stipulate exact rules on how the selection decision is made between multiple participants. The safest contractual option is, in our experience, to leave the appointment of all arbitrators to the institution, where for example, an intervener cannot agree on a candidate with the main party it is supporting.
This, of course, also raises the question of up to what point in proceedings it should be possible to join as an intervener. After all, an arbitral tribunal may very well be already constituted if the third-party notice is only issued at a later stage. For comparison, the Munich Rules allow for a third-party notice at any stage of the proceedings (§ 2 of Munich Rules). In contrast, the DIS-ERS generally limit a third-party notice to the very early stages, i.e., before the appointment of arbitrators, unless there is no objection by the recipient to the composition of the arbitral tribunal (Article 4 of DIS-ERS).
Clear rules on procedure and impact on institutional rules
Furthermore, the procedural impact of (possibly multiple) interveners joining the proceedings should be considered: The tribunal will have to take their respective participation rights into account, such as by giving them sufficient opportunities (and respective staggered deadlines) to submit their own briefs or to participate in the taking of evidence. Here, explicitly regulating interveners’ individual procedural rights can be advantageous. Also, a clear framework is necessary for third-party notices to be submitted and distributed (“served”) among the contractual parties.
Lastly, it is crucial to keep in mind that several features of institutional rules are not necessarily compatible with the third-party notice mechanism. Where needed, the intervention agreement should amend existing arbitration rules explicitly to give clear guidance to arbitrators on which provisions prevail. Careful drafting can prevent deadlock situations. Any template for an intervention agreement must therefore always be adjusted to the specific institutional rules chosen (e.g., regarding costs, the appointment of arbitrators, and confidentiality) and with a view to the specifics of the seat of the arbitration.
Costs of proceedings and allocation
Regarding the costs of proceedings, institutional rules do not take into account the possibility of non-party participants. Parties considering using the third-party notice mechanism should therefore include detailed rules in this regard so that any potential cost participation of interveners is already evident at the time of their joinder. In particular, it should be clarified whether and how any costs caused by the participation of intervenors are to be shared among the participants in the proceedings.
Conclusion
The third-party notice mechanism modeled after German procedural law offers a unique opportunity to resolve disputes between multiple parties and across multiple contracts efficiently and consistently. This instrument can become useful for large-scale construction projects, complex M&A transactions, or similarly complex business relationships if incorporated into the respective arbitration agreement. However, the rights and obligations of all parties and non-party interveners participating in arbitration should be carefully considered when drafting complex “intervention agreements”—a plain model arbitration clause will not suffice. In this way, the advantages of arbitration can be maintained by providing instruments already available in litigation in many civil and common law countries by default.
* Georg Scherpf heads the German arbitration team at Clyde & Co. He has represented clients in ad hoc arbitrations seated in Germany, England, Switzerland, Austria, France, and Singapore and also under various institutional rules (DIS, ICC, LCIA, VIAC, AAA, SIAC, and SCAI). Georg’s commercial arbitration track record covers a broad range of legal issues and sectors, including international trade (CISG), corporate disputes (joint venture and post-M&A), energy (particularly offshore wind, PV, and CSP), as well as technically complex construction disputes. Admitted to practice in Germany and England and Wales, he advises on both German and English law.
** Antonios Politis is an associate in Clyde & Co’s global arbitration group in Hamburg, Germany. He advises and represents both private and State parties in domestic and international arbitration proceedings as well as in complex cross-border disputes before German courts. He holds a Master of Laws (LL.M. ‘18) in International Business Regulation, Litigation, and Arbitration from NYU School of Law. He is admitted to practice law in Germany (as Rechtsanwalt) and New York (as Attorney at Law).
*** Dr. Benedikt Yuji Kaneko currently works as a law clerk at the Higher Regional Court of Hamburg as part of the mandatory two-year clerkship for admission to the German bar (Referendariat). He is admitted to the New York Bar (as Attorney at Law) and has experience acting in commercial and investment arbitrations under various institutional rules (ICC, SIAC, KCAB, UNCITRAL, and ICSID).