Arbitration Clauses in Plant Construction

Why the arbitration clause is being passed down the chain

The general contractor wants to establish uniform rules for dispute resolution throughout the supply chain. If the general contractor is bound by arbitration with respect to the end customer, it wants to be able to seek recourse against its subcontractor under the same framework. Otherwise, the general contractor will be sued before an arbitration tribunal in London and will have to sue its subcontractor in the Stuttgart Regional Court, facing different procedural rules, different methods of taking evidence, and the risk of conflicting outcomes. There is no third-party notice that would prevent this between an ICC arbitration and state court proceedings.

That is a legitimate concern, but simply mirroring the clause only partially resolves it. An arbitration clause with identical wording does not make the subcontractor a party to the arbitration proceedings between the end customer and the general contractor. Without coordinated clauses and the consent of the parties involved, there will still be two separate arbitration proceedings. For the subcontractor, what matters in any case is whether the clause is acceptable to them personally.

How Much Arbitration Costs a Subcontractor

Arbitration is significantly more expensive than proceedings before state courts. In addition to attorneys’ fees, there are the fees charged by the arbitration institution and the arbitrators’ fees; the state pays the judges at the regional court. Under the ICC Rules of Arbitration, if the amount in dispute is three hundred thousand euros, the expedited procedure applies automatically—in which, as a rule, a sole arbitrator decides the case, even if the clause provides for three arbitrators. However, this applies only if the parties have not excluded it, and even then, the costs are significantly higher than the court fees of a regional court. If the proceedings are conducted in English, translation costs are added for the contract, correspondence, technical documents, and witness testimony. In a plant construction dispute involving extensive documentation, this constitutes a separate cost category.

Advance Payment and Reimbursement of Expenses

Added to this is the issue of advance payment. The ICC generally requires both parties to contribute equally to the advance payment. If the general contractor fails to pay its share, the subcontractor must cover it; otherwise, the subcontractor’s claim is deemed withdrawn. Ultimately, the arbitral tribunal decides on the reimbursement of costs at its discretion, taking into account, above all, the outcome of the proceedings (Section 1057(1) of the German Code of Civil Procedure [ZPO] for German arbitration seats; comparable provisions apply in the arbitration rules). The winning party is thus generally reimbursed for its costs, but only at the end of the proceedings and to an extent that is more difficult to predict than the cost allocation under Section 91 of the German Code of Civil Procedure (ZPO).

Cost Risk Associated with Smaller Claims

For a subcontractor or component manufacturer seeking to recover a final invoice in the mid-five-figure or low-six-figure range, the costs of arbitration may be disproportionate to the amount in dispute. The arbitration clause then effectively acts as a waiver of the right to sue, even though the claim exists. The general contractor who included the clause may not have intended this.

No appeal

An arbitral award is final. There is no second instance. If the place of arbitration is in Germany, the arbitral award may be set aside only pursuant to § 1059 of the German Code of Civil Procedure (ZPO), for example, due to an invalid arbitration agreement, a violation of the right to be heard, material procedural errors, or a violation of public policy. An incorrect application of the law or an erroneous assessment of the evidence does not fall under these grounds. Where the place of arbitration is London, English law applies, which likewise permits a review of the merits only within narrow limits.

For the general contractor, with a dispute amount of twenty million euros, this is a calculable risk; he handles the proceedings from the outset with the necessary effort. The subcontractor, who loses his claim of over three hundred thousand euros on the first and only attempt, no longer has any opportunity to have an error corrected. In state court, he would have had the option to appeal to the Higher Regional Court, which would have conducted a full review of the application of the law and, in cases of concrete doubt, reexamined the findings of fact (Section 529(1)(1) of the German Code of Civil Procedure (ZPO)). This second review is particularly valuable in technically complex disputes.

Enforceability

The main argument in favor of arbitration clauses in international business is enforceability. Under the 1958 New York Convention, an arbitral award is enforceable in 172 contracting states. There is no comparable network for judgments issued by national courts outside of Europe. For a general contractor seeking to enforce a judgment against an end customer in Saudi Arabia or Kazakhstan, the New York Convention is therefore indispensable.

However, the subcontractor’s contracting party is the general contractor, who is often based in Germany or, in any case, within the EU. A German judgment against a general contractor in Munich or Hamburg is enforceable as a matter of course; a judgment against a general contractor in France or the Netherlands is enforceable under Article 39 of the Brussels Ia Regulation without requiring a declaration of enforceability there. The argument supporting the arbitration clause in the main contract does not apply in this context.

The situation is different if the general contractor is based outside the EU or if the subcontractor supplies goods directly to a foreign client. In such cases, the arbitration clause may also be beneficial for the subcontractor. It is a mistake to include it in the main contract without addressing this issue.

Confidentiality

The confidentiality of arbitration proceedings is cited as an advantage. It is not a given, however: The DIS Rules of Arbitration require the parties to maintain confidentiality (Art. 44 DIS Rules of Arbitration), whereas the ICC Rules of Arbitration impose this obligation only on the arbitrators. Under the ICC Rules, the parties are bound by this obligation only if they have agreed to it.

To the extent that confidentiality exists, it primarily benefits the general contractor in the supply chain. The general contractor does not want its contractual structures and terms to become public knowledge, nor does it want other subcontractors to learn which of its clauses an arbitration tribunal has rejected. For the subcontractor, however, the public nature of government proceedings can serve as a means of leverage. A general contractor whose payment practices are discussed in a public hearing behaves differently than one who operates under the protection of confidentiality.

What a Subcontractor Should Do During Contract Negotiations

The arbitration clause is negotiable, even if the general contractor presents it as a requirement of the main contract. It is virtually impossible to remove it later. According to the case law of the Federal Court of Justice, an arbitration clause in general terms and conditions does not, in and of itself, unreasonably disadvantage the contracting party (BGH, judgment of January 13, 2005 – III ZR 265/03). If the subcontractor nevertheless files a lawsuit in state court, the claim will be dismissed as inadmissible upon objection by the general contractor (Section 1032(1) of the Code of Civil Procedure (ZPO)).

Agreement on a State of Jurisdiction

If the general contractor is based in Germany or the EU, the argument regarding enforceability does not apply. The subcontractor should then propose a jurisdiction clause in favor of a state court, which offers lower costs, the right to appeal, and public hearings. In response to the objection that the general contractor needs the arbitration clause for recourse, it can be argued that merely mirroring this provision only partially solves the problem.

Place of Arbitration, Language of the Proceedings, and Rules of Procedure

If the subcontractor must accept the arbitration clause because the general contractor is based outside the EU or the subcontractor lacks sufficient bargaining power, the specific terms of the clause are crucial. If the place of arbitration is in Germany, German arbitration law applies, and German courts decide on any annulment. A place of arbitration at the end customer’s place of business—with whom the subcontractor has no dealings—primarily results in additional costs. The language of the proceedings should be the same as that of the contract itself and the technical documentation. Furthermore, expedited proceedings must not be excluded. Under the ICC, expedited proceedings apply automatically unless the clause provides otherwise; under the DIS, they apply only if agreed upon.

Mediation or Conciliation as a Preliminary Step

A phased clause that requires mediation or conciliation prior to arbitration may also be advisable. For manageable amounts and clear facts, this allows a dispute to be resolved more quickly and cost-effectively. However, this preliminary stage must include a fixed deadline after which arbitration proceedings can be initiated; otherwise, it will only delay the enforcement of the final invoice.