Tips on Contract Negotiations for Non-Lawyers (Part 3)

The enormous practical importance of the question of which country’s courts will resolve disputes is obvious: Litigation abroad is always more costly than domestic litigation due to language barriers, travel, translation, and additional legal fees. Furthermore, there may be significant differences between countries in terms of procedural law and judicial practice, which can have a substantial impact on the course and, in particular, the duration of a legal dispute (which, for example, is typically very long in Italy).

If the parties do not reach a contractual agreement on which courts should have jurisdiction over the contractual relationship, the procedural laws of most countries affirm the jurisdiction of their courts if the party against whom the claim is brought is seated in the relevant country and/or the contractual place of performance is located in that country. 

The rule linking jurisdiction to the defendant’s seat and the place of performance applies uniformly throughout the EU. For example, if an Italian supplier fails to properly fulfil its contractual delivery obligations to a German customer, the customer may, at its discretion, bring a claim against the supplier either at the supplier’s seat in Italy or at the place of performance for the non-delivery, late delivery, or defective delivery. The place of performance for all claims arising from a supply contract is determined – unless otherwise agreed – by the place of performance of the delivery obligation. If the parties have agreed, for example, to DAP (Incoterms), the procedural place of performance for all contractual obligations would in this example be in Germany, thereby establishing a German venue. This would then apply to all claims arising from the contract, including, for example, the customer’s claims for payment.

However, particularly when linking jurisdiction to the place of performance, there may still be room for argument, except in clear-cut cases. The step of clarifying the court’s jurisdiction alone can then entail significant additional effort and delays. Therefore, it generally makes sense to explicitly agree not only on the jurisdiction of the courts of a specific country, but also of a specific location (e.g. Cologne). Furthermore, an agreement on the competent forum is recommended because it allows for alignment of jurisdiction and applicable law (see below 3.). This is because, theoretically, especially, especially when the statutory rules on jurisdiction apply (see above), an Italian court might also have jurisdiction over a contract governed by German law, which in practice regularly leads to significant complications. This can be avoided by ensuring that the choice of forum and choice of law provisions are aligned (e.g. competence of German courts over a contract governed by German law).

While, in principle, a certain degree of predictability and legal certainty exists for contracting parties within the EU even without a contractual agreement – though such an agreement is still recommended – this does not apply to contracting parties based outside the EU: Even if a court in Germany declares itself competent – for example, based on the statutory connection to the place of performance described above – and a judgment can be obtained there against the contractual partner based outside the EU, this can often be worthless in practice: If the state where the contractual partner is seated (e.g. China) has not concluded a reciprocal enforcement agreement with Germany, a successful judgment by a German state court cannot be enforced there.

In such cases, it is therefore essential to carefully assess in advance whether and under what conditions the subsequent enforcement of a judgment of a state court is even possible at the contracting party’s seat. It will almost always be advisable to conclude an arbitration agreement rather than a jurisdiction agreement since virtually all relevant economic nations have committed themselves under international treaty to the enforcement of foreign arbitral awards, whereas this is not so comprehensively guaranteed for judgments of foreign state courts. 

Just as important as the choice of the competent court or tribunal is the choice of the legal system applicable to the contract. This determines, among other things, (i) which statutory provisions apply in addition to the contractual agreements and (ii) whether certain contractually stipulated provisions are valid or invalid (for example, because they unduly disadvantage one contracting party). Even within the EU, the differences between the legal systems of the individual member states can be significant in this regard.

If the parties do not agree on the legal system applicable to the contractual relationship, the competent court will determine the applicable law in accordance with its relevant provisions. These provisions governing the applicable law apply uniformly within the EU (with the exception of Denmark). Accordingly, a contract is generally governed by the legal system with which it has the closest connection. This is typically the country in which the contracting party that performs the characteristic performance under the contract (in the case of a supply contract: the delivery of goods) is seated. In the absence of a choice of law, the law of the supplier’s or service provider’s seat (and in the case of distribution contracts: the seat of the franchisee, authorised dealer, or commercial agent) therefore applies.

However, even from the supplier’s perspective – although the domestic law familiar to the supplier would generally apply in the absence of an express agreement – an explicit and precise choice of law is often preferable. This is because, particularly as far as the sale of goods is concerned, the statutory reference to the legal system at the supplier’s place of business also incorporates the rules of the UN Sales Law, provided that the supplier’s home country is among the nearly 100 contracting states of the UN Sales Law (these include, among others, the EU Member States, the United States, and Canada; relevant exceptions include the United Kingdom and India, whose courts would not apply the UN Sales Law when dealing with the matter). Thus, if, for example, a German supplier and an Italian customer do not explicitly choose a governing law, German law would apply, but with the inclusion of the provisions of the UN Sales Law.

Even though the application of the UN Sales Law does not necessarily have to be disadvantageous for one party, the associated differences from national sales law provisions must be kept in mind: For while the UN Sales Law sometimes also provides for provisions that are advantageous to the supplier (withdrawal is possible only in the event of fundamental breaches of contract; damages are limited to the loss foreseeable at the time of conclusion of the contract; provisions regarding force majeure are included – unlike, for example, in German statutory law), it also provides for strict liability and (at least compared to German law) buyer-friendly provisions regarding the inspection and notification of defects of the goods. 

If one wishes to exclude the application of the special provisions of the UN Sales Law, which can be advisable, this must be expressly provided for in a choice-of-law clause. In addition to the (non-mandatory but possible) exclusion of the UN Sales Law, the choice of law should, as far as possible, be aligned with the applicable law with the agreement on the forum. This is because if a state court is required to apply the law of another state, this will always have a detrimental effect on the conduct and duration of the proceedings (see 2. above). For these two reasons, it will generally be preferable to enter into an express choice-of-law agreement.

As long as a contractual relationship proceeds smoothly, it initially makes no difference to the parties which legal system governs the contract or which court would be competent in the event of a dispute. However, as soon as deliveries are defective, payments are late, the validity of the agreed prices is in question, options for terminating the business relationship are being considered, or there is a dispute over whether an obligation to order or deliver exists and until when, the issues of jurisdictional competence and applicable law become decisive. This can lead to quantifiable and painful disadvantages:

If one has prematurely ceded ground to the contractual partner in this regard during contract negotiations, one may now find that a claim must be enforced or defended abroad. Or that the applicable legal system deems certain contractual agreements between the parties to be invalid and therefore, to the parties’ surprise, applies entirely different legal rules (namely those of the foreign law, not the contract) to determine the existence and scope of the disputed claims than the parties had previously assumed.

It is not necessarily the job of commercial negotiators to analyse themselves which agreements should ideally be made in this regard (as it does not necessarily always have to be most advantageous to negotiate the application of domestic law and competence of domestic courts). Rather, it is to recognize that these aspects can take on enormous practical importance, are not merely “l’art pour l’art,” and must therefore be duly analyzed and appropriate weight needs to be given to them during contract negotiations.