Dispute escalation provisions and International Arbitration - a rising threat in Germany?

This is the third article in Clyde & Co’s latest international arbitration series covering dispute escalation provisions and pre-action ahead of commencing international arbitration across various jurisdictions. In this piece, counsel Michael Pocsay from our Dusseldorf office provides the legal perspective from Germany.

A general objective of pre-action protocols is to allow the parties to an emerging dispute to understand each other’s position. This enables them to make an informed decision whether an amicable settlement of the dispute is possible or if commencing litigation or arbitration proceedings is necessary and appropriate.[1] While German procedural law generally does not impose any mandatory pre-action conduct,[2] it does include certain incentives for a claimant to work towards an out-of-court solution before filing a claim.

For instance, Section 93 of the German Code of Civil Procedure states that a claimant must bear the costs of litigation proceedings if the defendant has not prompted the filing of a claim by its conduct (eg by refusing to accept the claim[3]) and accepts a claim filed against it immediately. This includes, in particular, cases in which the defendant would have satisfied the claim if the claimant had requested payment or performance before initiating court proceedings. Section 93 Code of Civil Procedure thus serves to prevent unnecessary claims and protect the defendant from the cost risk of a legal action in cases where the latter is willing to accept the claim without a judgment but has not been given the chance to do so.[4]

Section 253 (3) no. 1 of the Code of Civil Procedure provides that a claimant should state in its statement of claim whether the parties have attempted mediation or another type of alternative conflict resolution prior to filing an action. The purpose of this (non-mandatory) requirement is also to encourage the claimant to consider attempting settlement before filing a claim.[5]

While these provisions (in particular Section 93) may encourage a claimant to attempt settlement before filing a claim in court, they are not directly applicable in arbitration proceedings. As with arbitration in general, any pre-action conduct required before initiating arbitration proceedings in Germany is a matter of agreement by the parties and thus an expression of the principle of party autonomy.

Escalation clauses

A common way to provide for a pre-action protocol through an agreement is to include an “escalation clause” or “multi-tier dispute resolution clause” in the contract. Such clauses provide for dispute resolution in several steps, typically by requiring the parties to attempt to resolve a dispute amicably (ie through negotiations and/or mediation) before being allowed to commence arbitration.

Validity of escalation clauses

The validity of escalation clauses is generally recognized under German law, provided that it is sufficiently clear to be operable in practice. An escalation clause providing for arbitration must, however, comply with the general requirements for the validity of an arbitration agreement as set out in Sections 1029 and 1031 of the Code of Civil Procedure. In particular, the arbitration agreement must pertain to disputes arising in respect to a defined legal relationship (Section 1029 (1)) and it must be contained either in a document signed by the parties or in an exchange of letters, telefaxes, telegrams or other means of telecommunication which provide a record of the agreement (Section 1031 (1)).

Temporary waiver of the right to claim

Where the parties have agreed on an escalation clause and a claimant initiates arbitration proceedings without having adhered to the agreed multi-tiered dispute resolution process, ie without having attempted settlement through negotiations or mediation, the question arises as to how this affects the arbitration proceedings.

The failure to comply with the requirement to conduct negotiations or mediation before filing a claim does not prevent the constitution of the arbitral tribunal,[6] just as a jurisdictional objection does not prevent the constitution of the arbitral tribunal. Instead, it is the responsibility of the arbitral tribunal to assess the impact on the arbitral proceedings of any non-compliance with an escalation clause.

Once the arbitral tribunal is constituted, it will thus have to decide if the escalation clause was validly concluded under the applicable law and if the claimant has met all pre-action requirements agreed in the escalation clause. Where this is not the case, the arbitral tribunal may reject the claim as inadmissible if the defendant objects to the non-compliance with the escalation clause.[7] This is because escalation clauses are generally construed as including a temporary waiver of the right to file a lawsuit.[8]

Nevertheless, German courts have held in some cases that a court action may be admissible despite non-compliance with the mediation requirement of a multi-tier dispute resolution clause where the applicable mediation rules would have allowed either party to terminate the mediation process unilaterally at any time. The courts reasoned that, in such cases, the requirement to mediate before filing a claim would be a mere formality.[9]

This last point illustrates a major challenge parties face when drafting escalation clauses. It is crucial that the clause gives clear guidance on when the transition from one step of the dispute resolution process to the next is admissible to be operable in practice. This can be achieved, for instance, by stipulating a clearly defined timeframe within which the dispute must be resolved before moving on to the next stage.

Section 1032 (2) of the Code of Civil Procedure

Besides preventing avoidable claims, complex questions of jurisdiction are often an issue in cross border disputes. In these cases, the parties (particularly the claimant) may benefit from the possibility of ascertaining which court or tribunal has jurisdiction before filing a claim.

In some jurisdictions, pre-action protocols may require a defendant to raise jurisdictional objections even before the initiation of proceedings, when they receive a letter of claim.[10] While such a pre-action protocol is not available in Germany, German arbitration law provides the opportunity of requesting a declaratory judgment from the Higher Regional Court regarding the admissibility of arbitration proceedings. Section 1032 (2) of the Code of Civil Procedure allows the parties to file an application to the court to declare whether arbitration proceedings are admissible prior to the composition of the arbitral tribunal. This gives them the opportunity of attaining clarity with regard to the validity as well as scope of an arbitration agreement before filing a claim in litigation or arbitration proceedings.

If the court declares that arbitration proceedings are inadmissible, a defendant cannot successfully invoke the objection that the court lacks jurisdiction due to the existence of an arbitration agreement if the claimant files a claim in court. If an arbitral tribunal issues an award in spite of the court’s declaration that arbitration is inadmissible, the prevailing view is that the award is null and void.[11] If, on the other hand, the court confirms the admissibility of arbitration proceedings and thus the jurisdiction of an arbitral tribunal, then the prevailing view is that this decision is binding on courts and arbitral tribunals.[12]

Conclusion

No mandatory pre-action protocols apply in Germany. It is the responsibility of the parties to take appropriate measures to avoid unnecessary legal action, for example through the use of escalation clauses requiring them to attempt settlement before initiating arbitration proceedings. At the same time, German arbitration law serves to prevent unnecessary delays due to jurisdictional objections by giving the parties the opportunity to clarify crucial questions of jurisdiction and admissibility of arbitration before filing a claim.