Competence-Competence vs. Judicial Review – Finding the Right Balance

Higher Regional Court of Munich, Decision of 24 November 2016 – 34 SchH 5/16

The decision of the Higher Regional Court of Munich deals with the interrelationship between § 1032(2) of the German Civil Procedure Code (“ZPO”), on the one hand, and Article VI(3) of the European Convention on International Commercial Arbitration of 1961 (“European Convention”), on the other. Pursuant to § 1032(2) ZPO, “[p]rior to the composition of the arbitral tribunal, an application may be made to the court to declare whether or not arbitration is admissible.” The European Convention does not provide for such a review mechanism. Rather, Article V(3) provides for a (provisional) competence-competence of the arbitral tribunal by stating that, “[w]here either party to an arbitration agreement has initiated arbitration proceedings before any resort is had to a court, courts of Contracting States subsequently asked to deal with the same subjectmatter between the same parties or with the question whether the arbitration agreement was non-existent or null and void or had lapsed, shall stay their ruling on the arbitrator’s jurisdiction until the arbitral award is made, unless they have good and substantial reasons to the contrary.”

The Higher Regional Court of Munich was faced with the question whether, in a situation where a request for arbitration had been filed with the ICC but the arbitral tribunal had not yet been constituted, precedence was to be given to the arbitral tribunal’s (preliminary) competence-competence, according to the principle of Article VI(3) of the European Convention, or to the possibility of an early assessment of the arbitral tribunal’s competence by the courts, as provided in § 1032(2) ZPO.

I. The Facts of the Case

A Hungarian and an Austrian company had concluded a delivery contract, including an arbitration clause providing for ICC arbitration seated in Munich. On the basis of this arbitration clause, the Hungarian purchaser filed a request for arbitration against the Austrian seller with the ICC Court, claiming damages due to delivery of defective goods as well as declaratory relief with regard to the Austrian party’s liability for further damages caused by the defective goods.

Before constitution of the arbitral tribunal, the Austrian seller (“Applicant”) filed an application pursuant to § 1032(2) ZPO with the Higher Regional Court of Munich, requesting that the arbitration proceedings be declared inadmissible due to the invalidity of the underlying arbitration agreement.

The Applicant argued that the term of the delivery contract, including the arbitration agreement, had expired even before the defective goods had been delivered and that, therefore, the arbitral tribunal was not competent to decide the dispute.

The Hungarian purchaser (“Respondent”) objected to this interpretation of the contract, and irrespective hereof, requested the court to stay the proceedings until the arbitral award was rendered pursuant to Article VI(3) of the European Convention.

II. The Decision by the Court

The Higher Regional Court of Munich granted the Respondent’s request for stay of the court proceedings.

The court held that, within the scope of the European Convention, courts must generally order a stay of the proceedings without conducting a comprehensive assessment of the validity of the arbitration agreement, unless “good and substantial reasons” (gute Gründe) not to stay the proceedings exist.

The court found the European Convention to be applicable as the arbitration agreement was “concluded for the purpose of settling disputes arising from international trade be-tween physical or legal persons having, when concluding the agreement, their habitual place of residence or their seat in different Contracting States”, as required by Article I(1)(a) of the Convention. The court further noted that Article VI(3) of the European Convention specifically deals with the question whether the arbitration agreement was non-existent or null and void or had lapsed and that this provision was applicable with regard to court proceedings under § 1032(2) ZPO, at least where the application pursuant to § 1032(2) ZPO is based on an alleged invalidity of the arbitration agreement.

Article VI(3) of the European Convention provides for the principle that, where an arbitration agreement exists, courts have to stay proceedings. The Higher Regional Court, therefore, had to decide whether § 1032(2) ZPO constitutes a general exception (Bereichsausnahme) to this principle by providing for the possibility of an early assessment of the validity of the arbitration agreement or, if this was not the case, which preconditions must be fulfilled in order to trigger the “good and substantial reasons” - exception Article VI(3) of the European Convention.

As a first step, the court took the view that the mere fact that the German arbitration law, in§ 1032(2) ZPO, provides for the possibility of an early determination of the arbitral tribunal’s competence does not per se constitute a good and substantial reason within the meaning of Article VI(3) of the European Convention not to stay proceedings initiated under § 1032(2) ZPO and therefore does not constitute a general exception (Bereichsausnahme).

The court reasoned that the parties to the European Convention introduced Article VI(3) to preserve the arbitral proceedings from recalcitrant parties invoking the invalidity of the arbitration agreement in state courts to obstruct the arbitration. Referring to Germany’s obligation under public international law to give effect to the treaties and conventions into which it has entered, the Higher Regional Court held that this rationale of Article VI(3) of the European Convention had to be taken into account when construing the provision of § 1032(2) ZPO. According to the court, the fact that § 1032(2) ZPO was enacted after the coming into force of the European Convention was not to be read as a sign that the German legislator intended to derogate from its obligations under the European Convention.

The court noted that delaying tactics could be countered by § 1032(3) ZPO, which allows arbitral tribunals to continue the arbitration despite pending court proceedings. However, in the court’s view, this provision could not prevent delays to the arbitration in all instances. Rather, such delay would be particularly likely if the state court had to decide not only on legal questions but if the court’s decision on the admissibility of the arbitral proceedings required the taking of evidence, particularly if such evidence not only related to the validity of the arbitration agreement but also the substantive claims raised in the arbitration.

The court therefore confirmed that, under Article VI(3) of the European Convention, a stay of court proceedings was the rule and that a decision by state courts on the admissibility of the arbitration before the decision of the arbitral tribunal on its competence was the exception, requiring “good and substantial reasons” not to stay the court proceedings in favour of arbitration.

As a second step, the court elaborated on the prerequisites of the exception and held that all relevant circumstances of the individual case had to be taken into account. With regard to the particular case, the court raised the following points as relevant:

(i) Whether the underlying arbitration agreement was obviously invalid, including whether applicable formal requirements had been complied with. In this regard, the court stated that, irrespective of the law applicable to the arbitration agreement, an assessment of the validity of the arbitration agreement would have required the taking of witness evidence on the parties’ respective understandings of the provisions on the term of the contract;

(ii) Whether grounds existed which allowed for the reasonable assumption that a later award would not be enforced. The court found no such grounds to be apparent.

(iii) Whether other grounds existed which justified a decision not to stay proceedings until an award is made, e.g. whether such stay of proceedings would cause irrepara-ble harm to the Applicant. The court dismissed the Applicant’s arguments in this regard. In this context, the court noted that effective legal protection was granted by the court’s prima facie assessment of the arbitration agreement and that the postponement of the comprehensive assessment of the admissibility of the arbitration agreement until after the award had been rendered did not cause irreparable harm to the Applicant.

(iv) Whether parallel court proceedings could have an impact on the arbitral tribunal’s decision on substantive issues. In this regard, the court observed that any evidence pertaining to the term of the contract would not only relate to the tribunal’s competence, but also to substantive questions, since the Applicant had based its request to dismiss the claimant’s claim, inter alia, on the purported expiry of the term of the contract.

In view of the above, the court limited the basis for its assessment on the documents provided by the parties. Based on a document-only assessment, it found the arbitration agreement not to be prima facie invalid and that no other reasons not to order a stay of proceedings existed.

III. Résumé

While German arbitration law is based on the UNCITRAL Model Law on International Commercial Arbitration (1985), the German legislator, by introducing a review mechanism before the constitution of the arbitral tribunal, deviated from the Model Law. The relevant § 1032(2) ZPO was introduced as to provide certainty on the admissibility of arbitral proceedings at the outset of the procedure and thus to avoid fruitless arbitrations.

In the present decision, the decision of the Higher Regional Court of Munich clarified that, where the European Convention is applicable, proceedings under § 1032(2) ZPO must be stayed in the presence of an arbitration agreement unless exceptional circumstances exist. In this regard, courts will assess all relevant facts of the individual case, including whether the underlying arbitration agreement is prima facie invalid. If this is not the case and if no other good and substantial reasons within the meaning of Article VI(3) of the European Convention exist, an in-depth assessment of the tribunal’s competence will only take place at the enforcement stage after an arbitral award has been rendered. By contrast, if the court comes to the conclusion that the arbitration agreement is prima facie invalid, a full assessment will take place within the proceedings under § 1032(2) ZPO. In this case, it lies within the arbitral tribunal’s decision to stay the arbitral proceedings or to continue with the arbitration irrespective of the pending court proceedings.

This construction of the interplay between Article VI(3) of the European Convention and § 1032(2) ZPO significantly limits the competence of courts in favour of a provisional competence-competence of arbitral tribunals.

The Regional Court of Munich expressly allowed the appeal (Beschwerde) to the German Federal Supreme Court, since the case raised a fundamental question of law. It remains to be seen whether the Federal Supreme Court will follow the Regional Court’s reasoning which stands as a sign of the pro-arbitration stance of German jurisprudence.

The original full text of the decision can be accessed under the following link: http://www.gesetze-bayern.de/Content/Document/Y-300-Z-BECKRS-B-2016-N-20281?hl=true