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15 April 2021
The right to be heard is a universally accepted principle. The Federal Constitutional Court has described it as a 'primordial procedural right'.(1) It is guaranteed by Article 103(1) of the Constitution. For arbitral proceedings, it is also explicitly spelled out in Section 1042 of the Code of Civil Procedure. The right to be heard consists of three pillars:
The Federal Court of Justice treats the right to be heard as a cornerstone of modern arbitration proceedings. As such, it forms part of German public policy and its violation can be invoked to set aside an arbitral award. While no statistical data exists, a violation of the right to be heard is considered to be the most invoked ground in set-aside proceedings – albeit, usually to no avail.(2) A violation of the right to be heard is often invoked simply because a party is unhappy with an arbitral award. For example, it is easy to argue that an arbitral tribunal failed to consider a crucial argument or a certain witness when, as is often the case, a party's submissions are hundreds or even thousands of pages long. Fortunately for arbitration, the courts identify and penalise apparent violations of the right to be heard where there is compelling evidence. However, the courts also defer to the arbitral tribunal's discretion on how to conduct the proceedings and draft an arbitral award and do not replace the arbitral tribunal's assessment of the facts and law with their own (prohibition on substantive review).
Three decisions demonstrate that Germany – potentially more so than other arbitration-friendly jurisdictions – is a place where parties to arbitration can rely on the courts to take a robust approach, upholding an arbitral award if in doubt.
Confirmation of high threshold for finding of violation of right to be heard
In its November 2020 decision in a landmark warranty and indemnity insurance case, the Frankfurt am Main Higher Regional Court rejected an application to set aside an arbitral award in a landmark decision on coverage under a warranty and indemnity insurance policy.(3) The underlying arbitration arose out of Lixil's acquisition of German sanitary fittings manufacturer Grohe, for which Lixil had taken up a warranty and indemnity insurance policy from a 'tower' led by AIG. After the acquisition, Lixil discovered accounting manipulations at a China-based subsidiary of Grohe. Lixil subsequently sued AIG in arbitration proceedings. The arbitral tribunal, which consisted of three well-regarded German practitioners, decided that the €30 million in damages claimed (ie, the first layer of the insurance coverage) – which had been incurred as a result of these accounting manipulations – was not covered by the insurance agreement because liability for such manipulations had been excluded.
In the court proceedings, Lixil argued, among other things, that the arbitral tribunal had violated its right to be heard by:
The court started its analysis by highlighting that a violation of the right to be heard automatically leads to a violation of public policy and thus entails that the arbitral award be set aside. However, the court did not find that such a violation had occurred. The court emphasised that an arbitral tribunal need not expressly address every aspect of a party's submission as it can generally be assumed that an arbitral tribunal has noted and considered the parties' submissions. This would be different only if specific circumstances showed that the arbitral tribunal had failed to note a certain submission or consider such a submission when rendering the decision. The latter could be assumed only if the arbitral tribunal failed to address the core of a party's submission on an issue that was central to the dispute.
In relation to the assertion that the arbitral tribunal had failed to consider specific witness statements, the court highlighted that this was essentially a criticism of the arbitral tribunal's assessment of the evidence. Based on the principle that a substantial revision is prohibited, the court decided that it was not competent to replace this assessment with its own. The court added that the prohibition on substantial revision even applies where an assessment of the evidence is patently wrong.
In relation to the assertion that the arbitral tribunal had rendered a surprise decision by deviating from a communicated factual and legal assessment, the court noted that the arbitral tribunal had not communicated such an assessment; in any event, the applicant had addressed the allegedly surprising issues in its written submissions.
Essentially, the court's decision is a reminder of the high threshold for the finding of a violation of the right to be heard, particularly when it relates to an alleged failure to consider certain party submissions or witness testimony. Its absolute stance on the prohibition on substantial revision is also a good sign for any party considering whether to arbitrate in Germany. In fact, it serves as a differentiating factor if compared with other popular jurisdictions such as England, where, in a limited category of cases, an arbitral award may be subject to appellate review by the English courts for substantive errors of law.
Court defines limits to arbitral tribunal's discretion in high-profile nuclear power plant case
Unlike in the abovementioned case, requests to set aside an arbitral award for a violation of the right to be heard are not always unsuccessful. In a rare case, the Federal Court of Justice set aside an arbitral award for this reason in July 2019.(4) The underlying dispute concerned the construction of a nuclear power plant in Olkiluoto, Finland – a project that led to a multibillion-euro arbitration involving Areva, Siemens and TVO. In this case, a sub-supplier requested payment of more than €150 million. The arbitral tribunal largely rejected the claim so that the respondent's claim for cost reimbursement exceeded the awarded claim. The Düsseldorf Higher Regional Court initially declared the arbitral award enforceable but the Federal Court of Justice overturned that decision and set aside the arbitral award. The case was remarkable because it showed that even in high-value arbitrations with presumably renowned arbitrators – the names of the arbitrators have not been identified – grave mistakes can happen.
The arbitral award was 107 pages long, but the arbitral tribunal's decision on the core issue amounted to only one-and-a-half pages. In this case, the Federal Court of Justice held that the arbitral tribunal had not engaged with the claimant's actual arguments. In unusually harsh words, the court stated that the arbitral tribunal had relied on a submission "pulled out of thin air", a submission which the claimant had not made, to reject the claim. The court considered that the Düsseldorf Higher Regional Court's failure to realise the arbitral tribunal's shortcomings constituted an additional violation of the right to be heard. The Federal Court of Justice added that contrary to the Düsseldorf Higher Regional Court's decision, it was insufficient that the arbitral tribunal had:
Unsurprisingly, the Federal Court of Justice determined that this could not make up for the arbitral tribunal's apparent failure to consider a core submission. In its decision, the court also held that in view of the apparent and grave violation of one party's right to be heard, the case could not be referred back to the arbitral tribunal that had rendered the arbitral award.
No surprise decision if arbitral tribunal does not share either party's legal assessment
An additional case decided by the Frankfurt am Main Higher Regional Court sheds light on the concept of a surprise decision.(5) The underlying arbitration concerned a dispute between a German producer of medical devices and its Hong Kong-based distributor for the Chinese market. The German party attempted to terminate the contract when its distributor failed to obtain a re-certification of the products for the Chinese market. The claimant argued that it had declared the termination of the distribution effective as of 31 December 2014, whereas the respondent argued that due to a failure to submit the termination declaration to the correct addressee, as well as a lack of grounds for termination, the contract remained effective. The arbitral tribunal did not follow either legal argument. Even though the claimant had apparently considered it necessary to declare a termination, the arbitral tribunal assumed that the distribution agreement had automatically ended on 31 December 2014 because the conditions for a prolongation had not been met. This had not been argued by the claimant, neither contemporaneously nor in the arbitration.
In its 18 June 2020 decision, the Frankfurt am Main Higher Regional Court declared the arbitral award enforceable. The court held that there was no evidence that the arbitral tribunal had failed to consider witness statements, such as the testimony from the claimant's witness who considered a termination necessary. Instead, the arbitral tribunal expressly stated that it had arrived at its legal conclusion despite the fact that the claimant had not adopted it at the time, even though it would have been favourable for it to have done so. The arbitral tribunal considered the claimant's subjective views less important than the – in its opinion – clear wording of the contract. In the court's view, the respondent's argument that the witness statements should have led the arbitral tribunal to decide otherwise essentially amounted to a request to reconsider the evidence – an inadmissible substantial revision. The court's decision also reflects the German understanding of the concept of iura novit curia (ie, the court knows the law) in arbitration proceedings – the arbitral tribunal was free to adopt a legal view that differed from the views of both parties.
The court also held that the arbitral tribunal's decision did not amount to a surprise decision that would have violated the right to be heard. The court reiterated the general principle that a surprise decision can be assumed only if the decision – without any prior indication by the arbitrators – relies on an aspect with which no diligent and knowledgeable party needed to reckon. However, in this case, the chair had posed questions to a witness who pointed to his understanding that no termination was necessary. In addition, the arbitral tribunal hinted at this understanding in its directions for the post-hearing briefs. In view of this, the court held that the decision could not have come as a surprise to a diligent and knowledgeable party. The court concluded by highlighting that, in any event, an arbitral tribunal is under no obligation to share its legal assessment with the parties. In that context, the latter statement indicates that the court would have upheld the arbitral award even without the arbitral tribunal's indications that it may take a legal view that differed from the parties' submissions. In that sense, the approach taken by the court differs from other arbitration-friendly jurisdictions like Switzerland and France where arbitral awards have been set aside because arbitral tribunals ex officio applied facts or legal principles without giving the parties an opportunity to be heard on their application or because the arbitral tribunal failed to inform the parties of its intention to apply a legal reasoning that differed from the parties' positions.(6)
For further information on this topic please contact Anke C Sessler or Max Stein at Skadden Arps Slate Meagher & Flom LLP by telephone ( +49 69 742 200) or email (firstname.lastname@example.org or email@example.com). The Skadden Arps Slate Meagher & Flom LLP website can be accessed at www.skadden.com.
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