Probably an easy answer to this

Player 1 attacks Player 2 in multiplayer. Player 3 has a Title that supports Player 2 so they can opt to defend a challenge that player 2 chooses not to defend.

Play 1 attacks player 2 with characters who have stealth. Player 2 knows that all his characters could be bypassed with stealth so does not wish to defend.

At what point do they decline to defend (thus allowing player 3 to step in)

I assume it is after Player 1 has declared stealth targets. If this is the case, and Player 2 then chooses not to defend (or cannot defend) then I assume Player 3 can then choose to defend.

Can Player 1 use now use stealth on Player 3's characters or has the chance gone (or potentially been "used" if they stealthed Player 2's characters already)?

To save everyone's time I found the answer (and it makes sense) - Player 1 can't strealth Player 3 as the chance to do this has passed (and could never be possible as they could only stealth player 2 at the time)

This also kind of makes sense in a thematically as Player 1 (probably) only expected to face Player 2 and so is surprised when Player 3's armies turn up!