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Arbitrating Complex Disputes using Third Party Notices

  • Market Insight 12 September 2022 12 September 2022
  • UK & Europe

  • International Arbitration

For cross-border projects and business relationships around the globe, arbitration is used to resolve disputes once and for “all”. The finality is often given, but is the dispute also resolved for “all”? In this Clyde & Co Insight, Georg Scherpf (Counsel), Antonios Politis (Associate) and Benedikt Kaneko (Research Assistant) look at ways and initiatives to adapt the concept of third party notices to arbitration.

Especially in complex projects involving multiple parties and several layers of contractual relationships, it often comes to lengthy and expensive recourse proceedings e.g. against subcontractors, where almost identical facts are argued all over again. Apart from the unnecessary and avoidable costs of arguing the facts more than once, there is also a significant risk for the involved parties: Despite the common use of warranties and indemnification clauses in back-to-back contracts with subcontractors (e.g. based on the FIDIC Yellow Book Subcontract), the possibility of contradictory rulings on the same subject matter could lead to the loss of recourse claims against subcontractors in the vertical contractual chain.

A possible remedy lies in the procedural instrument of third party notices modelled after German procedural law. By creating a binding effect for recourse proceedings, third party notices prevent contradictory rulings and thereby increase the efficiency of dispute resolution in complex multiparty projects.

Third party notices under German procedural law

Third party notices are a popular tool whenever multiparty contracts are being litigated before German state courts. This procedural instrument – in German “Streitverkündung” – based on Section 72 et seqq. German Code of Civil Procedure (Zivilprozessordnung) may be used by either of the parties already involved in a litigation. Usually, the starting point is a party which 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).

In short, the already involved party can submit a third party notice to the court, asking for it to be served on a specific third party. The recipient of the third party notice can then decide whether it wants to join the ongoing proceedings as a so-called “intervener” in support of one of the main parties (“Nebenintervenient” or “Streithelfer”) or not.

  • If the third party joins the ongoing proceedings as an intervener, it directly participates in the proceedings with certain rights of its own: The intervener has the right to make procedural applications, submit briefs (including evidence) and raise defenses, as long as any of these actions do not contradict the procedural declarations and actions of the supported main party. However, the third party cannot be the addressee of any obligation under the resulting judgment since it only joins as an intervener and not as a “full” party – which is also the main distinction from the classic “joinder” (“Streitgenossenschaft”).
  • On the other hand, if the third party refuses to join the proceedings as an intervener, the litigation continues without that third party.

Regardless of whether the third party joins as an intervener or not, the main advantage of third party notices does not lie in the ongoing “primary proceedings” but in (potential) subsequent proceedings, i.e. in case of recourse claims against the third party. In such “recourse proceedings”, the third party is bound by the findings of the primary proceedings – even though not being involved as a “full” party there. By creating this binding effect of the primary ruling (so called “Interventionswirkung”), third party notices prevent contradictory rulings on the same subject matter across different proceedings. Importantly, the third party in potential recourse proceedings generally cannot argue 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 German Code of Civil Procedure). Of course, this creates a strong incentive for the third party to join the primary proceedings in the first place.

Can it be transposed to arbitration?

Through the binding effect for recourse proceedings, the instrument of third party notices contributes to the efficient dispute resolution between multiple parties and across multiple contractual relationships in German state courts. It provides an interesting mechanism that can also be made use of in arbitration by including respective provisions in the arbitration clause. Already today, it is increasingly found in complex projects relating to infrastructure and energy investments requiring all potential recipients of third-party notices to sign the same arbitration agreement and agree to a mechanism of third party notices.

However, institutional arbitration rules are currently not designed to accommodate this involvement of non-parties with specific procedural rights as none of the major arbitral institutions have provided for third party notices in their arbitration rules and model arbitration clauses. Rather, third parties are generally understood to participate either as regular parties by way of joinder or consolidation, or as non-parties for example by way of only having the possibility to weigh in by submitting amici curiae briefs without any actual procedural rights. Due to this lack of specific rules on participation by non-party interveners, the risk of a conflict between the institutional rules and the third party notice-mechanism included in the arbitration clause is high. Most arbitrators will try to adapt the rules applicable to the regular joinder to interveners or will have to make ad hoc decisions on the procedural rights of interveners.

To mitigate such issues without the necessity of drafting bespoke arbitration agreements, there are some initiatives to develop easily usable rules in this regard:

  • 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 recently published a third draft on  “Supplementary Rules for Third Party Notices” (Ergänzende Regeln für Streitverkündungen – “Draft DIS Supplementary Rules”) for discussion. These rules – once finalized – are meant to be incorporated by a mere reference in addition to the DIS Arbitration Rules. They adapt main features of the German regulation of third party notices (Sections 72 et seqq. German Code of Civil Procedure) for arbitrations under the DIS Arbitration Rules and also contain rules meant to adjust this procedural instrument for the particularities of arbitration (for example, rules on the participation of interveners in the selection of arbitrators). A third party notice recipient will be bound by the findings of the primary proceedings for the purpose of any proceedings concerning the recourse claims and will have similar rights as a third party notice recipient in German state court proceedings. Importantly, an application of the rules and the possibility for a third party notice depends on all parties, including the third party/prospective recipient of the third party notice, to have consented to their application.
  • Furthermore, there is another initiative focusing on including rules on third party notices in the arbitration agreement itself. A group of German practitioners has drafted the “Munich Rules on the Participation of Third Parties in Arbitration Proceedings” (“Munich Rules”), which aim to incorporate elements of the German third party notice-mechanism by virtue of 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 agreement, primarily address the relationship between the parties in an arbitration and one party’s possibility to issue third party notices. Interestingly, 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 binding effect between the issuer of the third party notice and its recipient depend on the recourse relationship connecting the two parties. However, only if the recourse relationship is of a contractual nature (e.g. a subcontractor contract) there is room to stipulate these consequences. Therefore, the “binding effect” is only triggered if and to the degree that it is agreed upon in the recourse relationship (if at all possible), which will very often not be the case. In such cases, the above-mentioned “incentive” for a third party to join the pending proceedings will be limited.

Notwithstanding various unresolved issues, which will certainly continue to be a source of discussion, these and similar sets of rules could, once included in institutional rules, lead the way towards a more efficient resolution of multi-party contract disputes.

Key issues to consider when drafting arbitration agreements including third party notices

Until then, it is necessary to negotiate bespoke arbitration agreements which cover not only bilateral situations but the participation of third parties in ongoing proceedings and also the binding effect of the first tribunal’s findings for any recourse proceedings. When considering opting for such an agreement, there are some key issues parties should consider:

  • In terms of a binding effect, first of all, it is necessary to have an agreement between all parties on all contractual levels in place – i.e. specifically including prospective addressees of recourse claims. Ideally, all parties should sign a separate arbitration agreement containing the third party notice-mechanism in addition to the contracts in their respective contractual relationships. As a result of such a “multilevel arbitration agreement”, all involved parties can be certain that the primary ruling will have a binding effect for any recourse proceedings. The incentive will therefore be high to resolve the dispute – as far as possible – as a “One Stop Shop” or at least in truncated and expeditious recourse proceedings.
  • Equally important is a clear mechanism on the appointment of arbitrators where non-party interveners are involved: Since a third party notice recipient has an interest in the arbitration due to its binding effect, it is important to establish a mechanism that balances the stakes and interests of all participants to the arbitration and that ensures the enforceability (binding effect) of the award.
  • Another aspect concerns determining the timing of any third party notice as to not disturb the arbitral proceedings and to ensure that the joining third party still has sufficient influence on the selection of arbitrators. For example, the Munich Rules allow for a third party notice at any stage of the proceedings, while the Draft DIS Supplementary Rules generally limit a third party notice to the very early stages, i.e. prior to appointment of arbitrators, unless there is no objection by the recipient to the composition of the arbitral tribunal.
  • 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 and e.g. provide for sufficient opportunities (and respective staggered deadlines) to submit own briefs or to participate in the taking of evidence. Here, it can be of advantage to explicitly regulate the individual rights.
  • Modern arbitration rules cater for consolidation and joinder, but so far do not provide rules or guidance for third party notices. It is important to keep in mind that several standard procedures and features of institutional rules are not necessarily compatible. Careful drafting can prevent deadlock situations.
  • It is also important to establish a clear framework how third party notices are to be submitted and distributed (“served”) among the parties. To ensure a functioning system overall, confidentiality rules in the individual contracts might also have to be adjusted to include parties that are involved in the overall dispute but are not privy to one of the contracts that might be relevant to the dispute. The Munich Rules contain wide limits to confidentiality in arbitral proceedings. The Draft DIS Supplementary Rules refer to the DIS Arbitration Rules and apply the ordinary rules on confidentiality on the third party.
  • Also, regarding the allocation of 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 include detailed rules in this regard so that any potential cost participation of interveners is already clear 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 to the proceedings.
  • Lastly, in terms of drafting the agreement, the multilevel arbitration agreement could be designed as a stand-alone agreement conclusively regulating all aspects of third party notices and their consequences for the primary and for recourse proceedings. Alternatively, the third party notice-mechanism could also be incorporated by mere reference to the mentioned provisions of the German Code of Civil Procedure, although the compatibility of these provisions with the particularities of arbitration should be carefully considered in each case. 

Overall, the rights and obligations that exist for all parties and non-parties to an arbitral proceeding should be carefully considered. Where needed, the multilevel arbitration agreement should amend existing arbitration rules explicitly in order to give clear guidance to arbitrators which provisions to follow.

Including a multilevel arbitration agreement for a complex project or business relationship provides for a unique opportunity to solve complex disputes between multiple parties and multiple contracts in an efficient and consistent manner. Our German energy and arbitration team regularly advises on the drafting and negotiating such complex arbitration agreements providing for third-party notices and other mechanisms for an efficient dispute resolution. The author Scherpf is also a member of the DIS working group on third party notices.

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