An efficient approach to arbitration in messy multi-party settings: Analysis of the proposal on DIS Supplementary Rules for Third-Party Notices in Arbitration

Dr. Lukas Schultze-Moderow
Gleiss Lutz, Hamburg

Emre Üngör​​​​
Gleiss Lutz, Hamburg

Introduction

Third-party notices are known to practitioners in most developed jurisdictions, albeit with different names. The German-speaking countries including Germany, Switzerland and Austria refer to the procedural tool as 'Streitverkündung'. Many common law jurisdictions are also familiar with the concepts of 'vouching-in' (in the United States), and 'third-party notices' (in England and Wales).^[1]  Notwithstanding the differences in terminology, domestic practices on third-party notices are similar in their nature. They are a useful tool to ensure the consistent adjudication of disputes without having to join all parties into a single proceeding, something that is of particular importance in the field of construction disputes and other multi-layered relationships where warranties, hold-harmless clauses and indemnifications are frequently of particular importance.

The basic concept underlying these procedural tools is the following: whenever a party believes that the outcome of a litigation will be decisive with respect to their claims against or liability towards third parties, that party may notify the respective third party. The notified third party may elect to participate in these initial proceedings or to stay out. In either case, in subsequent proceedings between the notifying party and the notified third party, the latter will not be able to claim that the decision in the initial proceedings was incorrect. 

In arbitration, the traditional approach to addressing comparable multi-party scenarios has been the use of mechanisms such as consolidation or joinder of parties. However, these mechanisms increase the number of ‘proper’ or ‘true’ parties and thus the procedural complexity. Joinder enables the addition of a new party that can raise its own arguments that can contradict the interests of any party participating in the arbitration. Likewise, consolidation is aimed at collecting all proceedings and claims in one forum, and hence does not draw boundaries to a party’s claims and arguments. To avoid these perceived disadvantages, practitioners have started a discussion on whether the well-known procedural tool of Streitverkündung can be adapted to arbitration. This has resulted in the proposed DIS Supplemental Rules for Third-Party Notices in Arbitration ('SRTPN').

In short, the SRTPN seek to maximize procedural efficiency while minimizing the risk of inconsistent rulings by different decision-makers. They seek to translate the concept of Streitverkündung into the realm of arbitration by adjusting for its particularities. The third-party notices foreseen in the SRTPN are an invitation to join one of the existing parties as a 'side party' or a 'secondary intervener', whose freedom to shape the process will be limited by the arguments of the supported main party. 

Third-party notices and the binding intervention effect

Procedural laws only govern third-party notices before state courts

The German Code of Civil Procedure (ZPO), the Swiss Private International Law Act (PILA), and the Austrian Arbitration Act are all silent on the use of third-party notices and their binding effects in arbitration. According to the prevailing view in all countries, the provisions embedded in domestic procedural laws are not applicable in arbitral proceedings. In Germany, a number of authors have correctly suggested that the binding effect foreseen under Sections 68 and 74 of the ZPO cannot be applied in subsequent arbitral proceedings absent an express declaration of consent to be made in advance by the notice debtor.^[2] The Austrian Supreme Court^[3], and an arbitral tribunal ruling under the International Chamber of Commerce (ICC) Rules of Arbitration and the Swiss procedural law^[4] have reached similar conclusions. To date, no German, Swiss, or Austrian court has endorsed third-party notices in arbitration.

Although the Swiss and Austrian laws on third-party notices are similar to the German provisions, when necessary, the following sections will focus on the German law, since the SRTPN are guided by Sections 68 et seqq. of the ZPO.

The SRTPN and third-party notices in arbitration

The proposed SRTPN offer an opportunity to notify a pending arbitration to third persons who are expected to raise warranty or indemnification claims against the main parties of an arbitration, in case of an unfavourable outcome.^[5] The proposed provision is akin to Section 72 (1) of the ZPO, which provides the same opportunity to the parties in state court proceedings. According to the SRTPN, the third person (hereinafter also referred to as the 'secondary intervener' or the 'notice debtor') shall be invited to join either one of the parties in support of the main party. Similar to what is stipulated under Section 67 second half of sentence one of the ZPO, Article 3.1 of the SRTPN allows the secondary intervener to raise claims, arguments, and defences insofar as they do not contradict the interests of the selected primary party. The secondary intervener also may decide to stay out of the proceedings.

Irrespective of whether the secondary intervener seizes on the invitation, the SRTPN suggest a binding effect of the arbitration on that secondary intervener.^[6]  According to Article 7.2. of the SRTPN, the secondary intervener shall be prevented from raising subsequent claims that the dispute in the main arbitration was decided incorrectly, or that the main party insufficiently protected the interests of the intervener. In other words, the binding effect means that the res judicata effect of the first arbitral award extends also to the notice debtor^[7], in the sense that the notice debtor will not be able to challenge the incorrectness of the first award.   

Alteration of domestic third-party notice rules to ensure compatibility with arbitration

The drafters of the SRTPN also considered the unique characteristics of arbitration as compared to court proceedings. The most significant departures from the ZPO, among others, are the need to obtain the notice debtor’s consent to the SRTPN in advance, and the pre-condition of granting the secondary intervener a say on the composition of the arbitral tribunal. 

According to Article 1.1 of the SRTPN, the two main parties, and at least one potential secondary intervener, should agree on the application of the SRTPN. The need to obtain the main opposing party’s consent accounts for the fundamental right to confidentiality in arbitration. Put differently, the counterparty’s right to confidentiality hinders the involvement of third persons, regardless of whether they join as a proper party or an ancillary party.^[8] 

Articles 4 and 5 of the SRTPN grant the right to the secondary intervener to participate in the constitution of the arbitral tribunal. According to Article 2.5 of the SRTPN, secondary interveners also can join the proceedings at a later stage, provided that they do not object to the constitution of the arbitral tribunal. In this respect, the SRTPN also deviates from the existing joinder procedure foreseen under Article 19.1 of the DIS Rules of Arbitration, which permits a joinder request only up until the appointment of the arbitrators.

What novelties do the SRTPN offer? 

The arbitration rules of the major institutions are often focused on arbitrations that involve more than one claimant and respondent. Although the rules provide solutions to the issues of multi-contract, joinder, and consolidation, they do not specifically cover third-party notices, in the way they are practiced in state court proceedings. For the moment, this remains true for the arbitration rules of the DIS^[9], ICC^[10], the London Court of International Arbitration (LCIA)^[11], and the Singapore International Arbitration Centre (SIAC)^[12] which administer arbitrations involving multiple 'parties'. Despite the lack of an express provision in the arbitration rules, it is generally accepted that parties may agree separately on a third-party notice procedure by virtue of a separate and explicit agreement.

Having said this, some arbitration rules seem more receptive to the idea of third-party notices in arbitration. For instance, the use of the term 'third person[s]' instead of third parties in Article 6 (4) of the Swiss Rules of International Arbitration^[13] ('Swiss Rules' 2021) has been interpreted as a conscious decision aiming to leave an open door to ancillary parties, such as third-party notice debtors.^[14] Similarly, Article 14 (1) of the VIAC Rules of Arbitration and Mediation ('Vienna Rules' 2021) enables the arbitrators to decide on the joinder of third parties, as well as on 'the manner' of the joinder. This provision is understood as one giving a green light to the inclusion of third persons, who need not join as ‘claimants’ or ‘respondents’.^[15]

The arbitration rules in other German speaking countries also have left some leeway for the parties to give third-party notices. This is likely not a coincidence, given these countries’ familiarity with Streitverkündung as an effective mechanism in dispute resolution. Yet, it is noteworthy that neither the Swiss Rules nor the Vienna Rules regulate the binding effect of third-party notices.

The SRTPN are not the first attempt at implementing the third-party notice procedure in international arbitration. The third-party notice rules enshrined in Sections 74 (3) and 68 of the ZPO have been adopted by the German Coffee Association which provides arbitration services in association with the Hamburg Chamber of Commerce.^[16] With the same intention, and in a similar vein, German practitioners have proposed the Munich Rules on the Participation of Third Parties in Arbitration Proceedings ('the Munich Rules' 2021).^[17] The Munich Rules are available to all parties that incorporate the rules in their arbitration agreements, and they are suitable for both institutional and ad hoc arbitration proceedings. 
At the end of the day, if the DIS adopts the SRTPN, it will be the first major institution to regulate third-party notices in arbitration

Can the SRTPN contribute to construction arbitration?

Third-party notices can be particularly useful in a series of vertical contractual relationships between contractors, which is sometimes referred to as the 'bilateral chain model' in construction projects.^[18] In the vast majority of construction and infrastructure projects, the works are not performed by one contractor. Regardless of whether the owner prefers to work with a single main contractor (for instance in an EPC/turnkey project), or with multiple main contractors, a main contractor often distributes its works to subcontractors. Quite often, the subcontractors also divide their works to further subcontractors, and thus establish a long chain of vertical relationships, with the subcontractor in the last link of the chain standing as a stranger to the owner and the main contractor.

However, in disputes arising out of such vertical relationships, the owner does not wish to hear the arguments of every single link in this chain, and resorts directly to the main contractor for compensation. A main contractor that acted wisely enough to conclude a back-to-back contract with its subcontractors (eg, through the FIDIC Yellow Book Subcontract) can avoid liabilities by virtue of its rights of recourse, but this strategy does not always protect the main contractor from all claims. To have a successful recourse, the main contractor is expected to act prudently and to defend a defect and/or delay that it has not caused in the first place.

In the current state of the arbitration practice, the main contractor that is faced with this risk strives to understand and defend the subcontractor’s arguments. Although this can be achieved by closely cooperating with the subcontractor and/or presenting the subcontractor as a witness, such cooperation is not always sufficient in the eyes of the subcontractor. Consequently, the subcontractor typically raises claims in later proceedings and asserts that the main contractor failed to properly defend its case against the owner. In a similar vein, the main contractor that had lost the first case can initiate a subsequent proceeding for recourse against the subcontractor, and the second case can also be decided in favour of its counter-party (ie, the subcontractor).

To avoid this scenario of being caught in the middle, the main contractor can convince both the owner and the subcontractor to agree to the SRTPN. Assuming that this attempt is successful, the subcontractor will have the opportunity to join the proceeding as an ancillary party to the contractor. Even if the subcontractor refuses to join the proceeding, the arbitral award of the first case will have a binding effect on the subcontractor.

In addition to joining the inviting party’s side, or refusing the request to join, Article 3.3 of the SRTPN provides a third option to the notified party. According to this provision, the notified party can join the proceedings on the main opposing party’s side (ie, the party that did not make the notice), provided that it can prove its legitimate interest in teaming up on this side. For instance, the notified party may have an interest in assisting the opposing party where such assistance may lead to an award that may relieve the subcontractor from its indemnity duties. Having said that, this third option appears relatively less likely to occur.

Last but not least, it should be noted that Article 2.6 of the SRTPN allows the notified party to serve a further notice on others. In other words, the owner and the main contractor that agree on the SRTPN also accept that the notified subcontractor can invite further sub-subcontractors that were involved in subsequent links of the vertical chain. The subcontractor’s ability to notify further third persons will depend on whether it agreed to the SRTPN with its own subcontractors.

Under the existing rules of the arbitral institutions, bringing all of the aforementioned parties to the same hearing room in such a scenario is possible only through joinder. For such joinder to be granted, the notifying party should specify its claims against the third party, and all parties should agree on the multi-party arbitration. In many instances, the existing institutional rules will come to the aid of those parties that wish to block a joinder after the constitution of the arbitral tribunal. After this point, the only strategy available is to appoint the same arbitrator(s) in subsequent proceedings to avoid inconsistent awards, which strategy is likely to be hindered by arguments relating to the arbitrators’ impartiality and conflict of interests.^[19]  For obvious reasons, owners are generally not willing to arbitrate with multiple parties that may also contradict and argue with one another, and thus cause delays in obtaining an award.

In a third-party notice type of intervention, however, the involvement of the subcontractor will cause relatively fewer difficulties and complexity for the owner. The owner may only abstain from agreeing on the SRTPN by considering that the possible involvement of the subcontractor may strengthen the main contractor’s case. In the future, it therefore seems advisable to include provisions regarding the application of the SRTPN before any disputes arise, ie, in the original contract(s).

Conclusion

The possible adoption of the SRTPN may increase the use of third-party notices in arbitration, since the DIS is a major arbitral institution that shapes the arbitration practice in Germany. It is yet to be seen whether the innovative stance of German practitioners also will inspire the drafters of other arbitration rules in the German-speaking world, where third-party notices are part of the legal traditions, and beyond. Third-party notices may be useful particularly in industries where the multiplicity of parties is the rule, rather than the exception, and where recourse claims are commonly seen. Construction arbitration is one such industry, which should welcome any solution – such as the SRTPN – that will facilitate the dispute resolution process.