Internationally working litigators and arbitration lawyers experience the following situation again and again: A US client believes that it might have a million dollar claim against a German contractual partner. The contractual partner refuses to pay. The US client therefore wants to enforce the claim in court, preferably at its “home courts”. The client has the greatest confidence in its home courts and the organizational effort is low. An action before the foreign court of the contracting party should be avoided at all costs. So far so good.
So what is the lawyer doing? She looks in the contract of the parties for an agreement on the place of jurisdiction. “The exclusive place of jurisdiction shall be Bonn, Germany”. Such clauses are standard in international contracts. Nevertheless, in practice, jurisdiction agreements often do not prevent clients from bringing an action before a court other than the agreed upon one. The hoped-for advantage of an action before the home court outweighs the risk of an inadmissible action due to lack of jurisdiction. It is often worth a try for clients. This especially applies to US clients. The reason for this are US procedural rules – in particular the so-called “American rule” – according to which each party must bear its own legal costs. Differently, in Germany the “loser pays“-principle applies (Sections 91 et seq. of the German Code of Civil Procedure (“ZPO“). As there are no similar cost rule in US law, a potentially inadmissible lawsuit in the US hardly encompasses too many risks.
This has changed – at least from a German perspective – due to a recent decision of the Federal Court of Justice (“BGH“). In its ruling of 17 October 2019, the BGH ruled on the substantive legal effects of jurisdiction agreements. According to the BGH, an action brought in violation of a jurisdiction agreement can justify a claim for damages (BGH, judgment of 17 October 2019 – Ref.: III ZR 42/19).
It is likely that this decision applies also to arbitration agreements. This is because arbitration agreements are comparable with jurisdiction agreements. Hence, a party might claim damages if it is sued before a state court even though there is a valid arbitration agreement. Litigators as well as arbitration lawyers should bear this in mind when suing a party before an incompetent state court or if their clients have been sued before a state court instead of an arbitral tribunal in the past.
Facts and course of the proceedings in Germany
The BGH had to decide on the following situation: In 2016, a US telecommunications company sued a German telecommunications company in the USA. The US company asserted contractual claims against the German company. The lawsuit was filed in the American District Court in Washington D.C. The German company challenged the action inter alia on the basis of an exclusive jurisdiction agreement in favour of the German courts in Bonn. The District Court dismissed the action due to a lack of jurisdiction. For the proceeding in the US only, the German company had to pay about USD 200,000 in attorney fees and other costs.
The US company subsequently filed a similar suit before the Regional Court in Bonn, Germany. In this lawsuit, the German company now counterclaimed the lawyer’s fee as well as all other costs incurred as damages (Section 280 German Civil Code (“BGB“). The Regional Court dismissed the claim of the US company but granted the counterclaim of the German company for damages (Regional Court Bonn, judgment of 8 November 2017 – Ref: 16 O 41/16). The court stated that an agreement conferring jurisdiction had primarily procedural effect. However, at the same time, there is also a substantive obligation to choose the agreed upon venue and not to bring an action before another court.
The Higher Regional Court in Cologne took a different view and rejected the counterclaim (Higher Regional Court Cologne, judgment of 26 February 2019 – Case No. 3 U 159/17). The Higher Regional Court held that the jurisdiction agreement only has procedural effects; the court did not see any indications of an additional implied substantive agreement.
Upon appeal by the German company, the BGH reversed the judgment of the Higher Regional Court in Cologne and referred the matter back to the court to decide on the amount of damages. The BGH held that jurisdiction agreements have a substantive legal effect under German law. The breach of a jurisdiction agreement causes a claim for damages under Sections 280, 249 BGB et seq.
Reasons for the decision of the BGH
In its decision, the BGH interpreted the jurisdiction agreement according to its wording and purpose. The BGHs decision is similar to the first instance decision by the Regional Court in Bonn. With their jurisdiction agreement, the parties mutually undertook to bring actions arising from the contract only in the agreed upon venue. The purpose of such agreements is to make legal disputes more predictable. Internationally active parties want to create legal certainty in this way. A so-called “forum shopping” – i.e. the selection of the allegedly best place of jurisdiction – should be excluded.
According to the BGH, for this purpose it is necessary that jurisdiction agreements have substantive legal effect. In other words, if the purpose of “legal certainty” is contradicted by recourse to a court in violation of the jurisdiction agreement, the only cure is to grant the other party a claim for damages seeking reimbursement of costs.
In addition, the BGH refers to two general principles of German law (which was applicable in the case): Firstly, Section 280 (1) BGB establishes the general principle that non-observance of contractual obligations may give rise to a claim for damages. And secondly, Sections 91 et seq. ZPO contain a general principle of German law according to which the losing party is obliged to reimburse the winner for costs. In the case decided by the BGH, the US District Court had not ordered such a reimbursement of costs.
With the lawsuit before the US court, the US company had thus intentionally violated a contractual obligation. As a consequence, the German company may claim damages pursuant to Section 280 (1) BGB.
Application to the breach of arbitration agreements?
In its judgment, the BGH ruled on the substantive legal effect of exclusive jurisdiction agreements. In practice, arbitration agreements often replace jurisdiction agreements. In international legal relations, arbitration agreements fulfil, among other things, the same purposes that the BGH emphasizes in jurisdiction agreements: parties want to make their disputes more predictable by means of arbitration agreements, create legal certainty and exclude “forum shopping“.
Against this background, it makes sense to apply the ruling of the BGH also to arbitration agreements. A party might then claim damages from another party if an action contrary to an arbitration agreement is brought before state courts. Whether the BGH actually grants substantive-law effect to arbitration agreement still remains open. Equally unanswered are follow-up questions, such as whether arbitral tribunals or state courts would be competent for such damages claims, because the reimbursement of costs is a principle anchored in German civil procedural law.
The decision of the BGH is extremely relevant for internationally working companies. For the first time, the BGH has dealt with the legal consequences of a claim in a “wrong venue”. The party suing in violation of a jurisdiction agreement owes damages to the other party. The BGH has strengthened the principle of pacta sunt servanda. In practice, the limitation period under German law of three years is now relevant (Section 195 BGB). Companies that in recent years had been exposed to unlawful actions and associated costs may still be able to claim damages. It remains to be seen how high the damages could be. In this respect, the case is back at the Higher Regional Court. As “damage”, the German company incurred an amount of approx. USD 200,000. It will be interesting to see whether the Germany statutory provisions of the Law on the Remuneration of Attorneys (“RVG“) will play a role in determining the amount of damage.