Germany’s Highest Court Upholds Validity of Arbitration Agreement which Excludes German T&C Law

In an important decision this year (I ZB 48/24), the German Federal Court of Justice confirmed that parties can agree to exclude the application of German law on general terms and conditions in their arbitration agreements without jeopardizing the validity of those agreements. This Legal Update takes a close look at this pro-arbitration decision and its implications for parties negotiating contracts with a German nexus.

BACKGROUND TO GERMAN T&C LAW

The core provisions under German law which govern general terms and conditions are sections 305 to 310 of the German Civil Code or “BGB” ("German T&C law"). German T&C law is known for its strictness, even in business-to-business contracts. While it is designed to protect parties from unfair or one-sided standard terms, its rigidity is often seen as a barrier especially in international transactions. For companies dealing with contracts that have a German nexus, there is a real risk that key clauses – such as penalty clauses or limitation of liability provisions – could be invalidated under German law. As a result, parties may seek ways to avoid the application of German T&C law, either by choosing a different governing law or by opting out of the German T&C provisions despite their mandatory nature. 

THE CASE: AN ARBITRATION CLAUSE, CONTRACTUAL PENALTY, AND THE EXCLUSION OF GERMAN T&C LAW

The case involves a standard form contract signed by two companies in relation to the construction of a solar power plant in the Netherlands. The contract included a penalty clause limited to 10% of the net contract sum. It also provided for arbitration under the rules of the German Arbitration Institute, with Berlin as the seat and German law as the governing law. Crucially, a sub-section of the arbitration clause expressly excluded the application of German T&C law (i.e. sections 305 to 310 of the BGB).

When the dispute arose, the applicant initiated arbitration proceedings, seeking payment for work performed. The respondent counterclaimed for defects, delays, and the contractual penalty. Before the arbitral tribunal had been constituted, the applicant filed a motion under section 1032(2) of the German Code of Civil Procedure (“ZPO”) with the Higher Regional Court of Berlin. This provision allows either party to an arbitration agreement to apply to a state court to determine the admissibility or inadmissibility of arbitral proceedings. Such an application can only be made before the constitution of the arbitral tribunal, even if the arbitration has already been initiated. The applicant sought a declaration that the arbitration clause in the construction contract was invalid, arguing that the exclusion of German T&C law would prevent the arbitral tribunal from properly reviewing the penalty clause. This could lead to the enforcement of a provision that would otherwise be invalid under German law, thereby rendering the entire arbitration clause invalid.

COURT RULING: ARBITRATION CLAUSE STANDS FIRM DESPITE OPTING OUT OF GERMAN T&C LAW

The Higher Regional Court rejected the motion, and, on 9 January 2025, the Federal Court of Justice upheld that decision on appeal. Below are the key takeaways:

• Principle of Severability: The Federal Court of Justice reaffirmed that an arbitration agreement is independent of other contractual provisions. This means that the validity of an arbitration clause is not affected by the validity or enforceability of other contract terms, including those that exclude German T&C law (sections 305 to 310 BGB). Even if the exclusion of German T&C law were found invalid, the arbitration clause remains effective regardless of whether it constitutes a standard term itself or whether it was freely negotiated between the parties.
• Limited Role of State Courts vs. Review by Arbitral Tribunal: The court further clarified that, in proceedings to determine the admissibility of arbitration under Section 1032(2) ZPO, the state court’s review is confined to the validity and enforceability of the arbitration agreement. It does not assess the parties’ choice of substantive law or specific rules in the main contract. The application of German law to the merits of the disputes lies with the arbitral tribunal. Any issues regarding the exclusion of German T&C law are to be addressed by the arbitral tribunal once constituted.
• Public Policy Safeguard: While the ruling gives parties broad autonomy to exclude German T&C law in arbitration, this autonomy is not absolute. The Federal Court of Justice emphasized that an award could potentially be challenged or refused enforcement on grounds of public policy. If the exclusion of German T&C law leads to contractual outcomes that are intolerable or fundamentally unfair, an arbitral award could violate German public policy. This safeguard ensures that fundamental principles of fairness and justice are preserved.

COMMENT: MORE FLEXIBILITY WITH A BACK DOOR

The ruling is a significant development for anyone negotiating contracts with a German nexus and considering arbitration as their dispute resolution mechanism. It reinforces the arbitration-friendly approach of German courts and gives parties greater freedom to tailor the applicable law to better fit their commercial needs. Even if parties choose German law as the governing law, they can opt out of the strict provisions of German T&C law in arbitration. This is not possible before German state courts, which must apply mandatory T&C law.

However, this autonomy is not unlimited. Arbitral awards may still be reviewed by courts on public policy grounds if the exclusion of T&C law leads to fundamentally unfair results. The ruling is therefore not a carte blanche for arbitral tribunals to completely ignore or misapply German T&C law. Parties should strategically consider whether (or not) to waive the protection by German T&C law in light of the remaining enforcement risks. The level of such risks will need to be carefully assessed with legal advisors at the time of contracting. 

Should you need to discuss the implications of this decision for your business, please contact any of the authors or your usual Mayer Brown contact.