Case of the Week: When is the Right Time for a Court Review of Arbitrator Appointments?

OLG MünchenIn arbitral proceedings, the jurisdiction of the state courts is limited (Section 1026 Code of Civil Procedure; Zivilprozessordnung, ZPO). On the one hand, while the arbitral proceedings are ongoing, the courts have powers to assist during the arbitral proceedings by deciding on the appointment and the challenge of arbitrators (Sec 1035 to 1039 ZPO). They can also to step in where the arbitral tribunal lacks jurisdiction and support the taking of evidence (Section 1050 ZPO). On the other hand, the state courts are competent to review the legality of the arbitral proceedings and the award once the proceedings have been concluded (Section 1059 ZPO).

The issue before the Munich Court of Appeals (Oberlandesgericht) earlier this year was whether a dispute between parties to an arbitration about the effectiveness of an arbitrator’s appointment can be decided during the arbitral proceedings on the basis of Sec 1035 para. 4 ZPO, or whether such a decision has to wait until the arbitral proceedings have been concluded and an award has been made.

Pursuant to Section 1059 para. 2 No. 1 d ZPO, an award can be set aside if “the formation of the arbitral tribunal or the arbitration proceedings did not correspond to a provision of this Book [i.e. 10th Book of ZPO, Arbitration Proceedings] or to an admissible agreement between the parties”, provided that it is to be assumed that these violation of the rules did have an effect on the arbitration award.

Facts of the case 

The parties had concluded the following agreement in a purchase agreement for a legal practice:

“In all disputes arising out of or in connection with this contract or its interpretation, performance, validity or termination, the parties undertake to first conduct conciliation proceedings with the Nuremberg Bar Association (Rechtsanwaltskammer) in order to achieve a balanced solution in line with their interests. Should the conciliation procedure not lead to a solution, each party shall be entitled to initiate arbitration proceedings. In this case, the dispute shall be finally settled by an arbitrator appointed by the President of the Nuremberg Bar Association, excluding the ordinary courts of law”.

After a dispute arose between the parties, one party initiated arbitration proceedings, in the course of which the Nuremberg Bar Association appointed the lawyer N. as arbitrator. The respondent objected and filed a motion with the Court of Appeals seeking a declaratory ruling that the appointment of lawyer N. as arbitrator was invalid. The parties were in dispute as to, inter alia, whether the conciliation procedure provided for in the arbitration clause still had to be carried out or whether it had been waived.

Decision

The Munich Court of Appeals rejected the application for a declaratory ruling that the appointment of the arbitrator was invalid. The First Senate of the Court of Appeals, which hears all arbitration related disputes for the entire federal state of Bavaria; has stated its reasons as follows:

 “Section 1035 (4) of the Code of Civil Procedure provides for the participation of the state courts only in the event that the parties have agreed on a specific procedure for the appointment of the arbitrator or arbitrators, but does not achieve the objective of this procedure. However, Section 1035 (4) ZPO no longer applies once the arbitral tribunal has already been constituted and there is a dispute as to whether the provisions reached have been complied with.

Section 1026 ZPO stipulates that the state court may only act within the framework of Sec 1025 to 1061 ZPO if the law expressly provides for this. (…) An extension of the powers of the state courts by way of case law is thus excluded.

It may make sense from the point of view of procedural efficiency to clarify as soon as possible whether the composition of the arbitral tribunal is in line with the parties’ agreement or not. Procedural efficieny, however, does not justify to extend the jurisdiction of the court beyond what is permitted by law. The fact that Section 1059 para. 2 no. 1 d ZPO allows parties to assert defects in the formation of the arbitral tribunal in the setting aside proceedings also supports the correctness of the aforementioned view. Moreover, the law restricts the possibility of setting an award aside by requiring that it must be assumed that these errors had an effect on the arbitral award itself. The legislator has made it clear that not every deviation from the agreement, however insignificant, should result in the arbitral award being set aside.”

The court further argues that an early decision by the state court on the validity of the arbitrator appointment would go against the legislator’s intention that not every defect of the appointment process must result in an award being set aside. Also, no criteria existed which would allow a court to determine early on which errors can still be tolerated. As parties have opted out of the state court’s jurisdiction, it would violate the party autonomy if they were “denied the right to solve problems first within the framework of arbitration proceedings and to give them the opportunity to agree on a procedure that is satisfactory for all parties involved, with the assistance of the arbitrator”.

This decision comes as a surprise. Back in 2011, the same senate of the Munich court had taken a different view. At that time, the court had held that the dispute between parties as to whether the appointment of arbitrators was effective and whether the agreed procedure for this had been complied with should be decided on the basis of Section 1035 para. ZPO. The court had applied Section 1035 para ZPO accordingly and had stated in its reasons that to refer the parties to other ways of clarifying this question that “was not reasonable from the point of view of procedural efficiency and was contrary to the principle of clarifying all disputes concerning the composition and jurisdiction of the arbitral tribunal as early as possible”.

In the case at hand, the Munich Court of Appeals has expressly abandoned its previous case law. In my opinion, it has done so without necessity and without a compelling reason. Its 2011 decision was in line with previous decisions of other courts of appeals and widely supported in the legal literature.

The court thus gives the parties stones instead of bread, attaching greater weight to the supposed dogmatic coherence than to procedural efficiency and certainty. The narrow interpretation of Section 1035 para 4 ZPO forces a party to defend itself in arbitration proceedings, which it considers illegal. In the worst case, the arbitration proceedings would have to be repeated if the resulting arbitral award is later set aside pursuant to Section 1059 para 2 no. 1 d ZPO.

Whether its approach of pushing the judicial review of the appointment procedure to the setting aside stage allows the parties, as the Court of Appeals hopes, to resolve their disputes “only within the framework of the arbitration procedure and to give them the opportunity to agree on a procedure which is satisfactory for all parties involved with the assistance of the arbitrator”, seems doubtful – this is a situation where one of the foundations of the arbitration, namely the selection and appointment of the arbitrator or arbitrators, is already in dispute.

Practical hints

Court of appeals decisions on the appointment of arbitrators are final (Section 1065 para. 1 ZPO). Thus, the Federal Supreme Court (Bundesgerichtshof) will not be able to unify the case law. Legal practitioners may have to live with diverging interpretations of Section 1035 ZPO in different court of appeals districts. It is therefore even more important to draft the arbitration clause in a manner that avoids ore at least minimizes the need for judicial intervention in the appointment process.

It is noticeable that both the 2011 and the 2019 decisions of the Munich Court of Appeals dealt with arbitration agreements between lawyers, one in a partnership agreement and one in a practice purchase agreement. In both cases, the parties choose ad hoc arbitration rather than institutional arbitration The parties would probably have been better off had they included the standard arbitration clause of an arbitral institution such as the German Arbitration Institute (Deutsche Institution für Schiedsgerichtsbarkeit, DIS) instead of drafting their own provisions – less is sometimes more. Institutional arbitration rules contain clear rules for the appointment of arbitrators, and allow the institutions to step in if problems arise.

Oberlandesgericht München, order (Beschluss) dated 26 June 2019 – file no. 34 SchH 6/18.

For those of you reading German, a slightly extended version including references to legal commentaries has been published on zpoblog.de.

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