In a judgment of 7 August 2015, the Court of Appeal Cologne had to deal with a claim for damages of a former respondent in arbitration proceedings. The respondent had lost the arbitration to a large extent. The tribunal ordered the respondent to reimburse the claimant’s costs of approx. EUR 730,000 including lawyers’ fees in an amount of approx. EUR 460,000. As it subsequently turned out, the claimant had in fact only paid to his lawyers’ fees in an amount of approx. EUR 280,000. The respondent claimed reimbursement of the overpaid amount.

  1. Content of the Judgment

The former respondent in the arbitration initiated proceedings before the District Court Bonn and claimed compensation for unconscionable damage pursuant to section 826 German Civil Code (Bürgerliches Gesetzbuch – BGB) arguing that he was defrauded by the claimant with respect to the amount of lawyers’ fees paid. The court dismissed the claim. In contrast, the Court of Appeal Cologne ruled in favor of the former respondent. In particular, the court held that neither the res judicata effect of the arbitral award nor the arbitration agreement between the parties rendered the claim inadmissible. A state court may disregard the res judicata effect if the award was obtained or is used unconscionably. The court held that the claim for damages is not covered by the arbitration agreement because the claim does not relate to a dispute which arose out of the underlying contract, but is rather based on the claimant’s behavior in the arbitration. The basis of the claim is an incorrect decision of the tribunal prompted by unconscionable conduct of a party, e.g. fraud. The claim seeks to create the financial situation that had existed but for the incorrect award.   The Court of Appeal Cologne thereby establishes jurisdiction of the state courts to correct unconscionably obtained arbitral awards. Essentially, the court reopened the proceedings and rendered a fresh decision on the merits, based on newly ascertained facts. However, the court lacked jurisdiction to decide on the damage claim. It erroneously interpreted the arbitration agreement between the parties and ignored the parties’ intention. The respondent would have had to bring the claim before an arbitral tribunal.

  1. No Jurisdiction of State Courts

The arbitration agreement between the parties stated that “all disputes arising out of or in connection with the contract” shall be settled by arbitration. Contrary to the Court of Appeal’s opinion, this agreement covered the damage claim asserted by the former respondent. It is true that the claim at issue resulted from a party’s behavior and it is also true that it was not based on the contract, but on statutory law. However, both facts do not establish jurisdiction of the state courts, since the claim resulted from a dispute that had arisen in connection with a contract that included an arbitration agreement. The court itself pointed out that the damage claim seeks to create the financial situation that would have existed had the case been decided correctly. However, according to the parties’ agreement, decisions on a dispute in connection with the contract were to be settled exclusively by arbitration.   In addition, the judgment is irreconcilable with section 1059 paras. 4 and 5 of the German Code of Civil Procedure (Zivilprozessordnung – ZPO): where an arbitral award has been set aside, the case has to be tried again in arbitration proceedings. According to the Court of Appeal Cologne’s decision, German state courts would even have jurisdiction to correct unconscionably obtained foreign arbitral awards if the debtor is seated in Germany or if the creditor intends to enforce the award in Germany (section 32 ZPO). This consequence contradicts the legislative principle expressed in sections 1059, 1061, 1062 para. 1 No. 4 ZPO: a German state court may only deny enforcement of a foreign arbitral award, but has no jurisdiction to set it aside.

  1. No Conflict of Damage Claim with Res Judicata Effect of the Arbitral Award

With respect to the principle that the res judicata effect of an arbitral award may be disregarded in case a party obtained or intends to use the award unconscionably, the Court of Appeal Cologne relied on settled case law of the German Imperial Court (Reichsgericht – RG) and the German Federal Supreme Court (Bundesgerichtshof – BGH) with respect to unconscionably obtained judgments. The courts regularly hold that German courts may disregard the res judicata effect of a judgment in case it has been obtained or is used unconscionably, e.g. in case of fraud, forged evidence, threat or compulsion (cf. RG judgment of 14 October 1905, I 143/05; BGH judgment of 13 September 2005, VI ZR 137/04). In such cases, a court may reevaluate a case despite a final and binding judgment. This principle is also applicable to arbitration proceedings because pursuant to section 1055 ZPO, amongst the parties, an arbitral award has the effect of a final and binding judgment issued by a court. The res judicata effect of an arbitral award is not stronger than the res judicata effect of a judgment.

  1. Choice Between Annulment Proceedings and Claim for Damages

In case of a domestic arbitral award which a party obtained or uses unconscionably, the defrauded party can choose to have the award set aside and/or to claim damages from the other party. The Federal Supreme Court (decision of 2 November 2000, III ZB 55/99) accepts an annulment of a domestic award in particular in two cases, namely in case of a violation of public policy (section 1059 para. 2 No. 2 lit. b ZPO) or in case of unconscionable intentional damage (section 826 BGB) which – according to the Federal Supreme Court – is not quite the same. For an annulment of the award due to violation of public policy, the court requires all statutory prerequisites of an action for annulment of a state court judgment or retrial of the case within the meaning of sections 579 et seqq. ZPO. In particular, the party which has unconscionably obtained the award must have been convicted for a respective offence by a final judgment. With respect to the annulment of the award due to unconscionable intentional damage within the meaning of section 826 BGB, the court “only” requires an incorrect decision which is based on one party’s unconscionable conduct. A conviction for an offence is not a prerequisite.   According to the Federal Supreme Court, the application for annulment of the award on the basis of section 826 BGB is admissible unless the arbitral award has been declared enforceable. If the defrauded party becomes aware of the unconscionable circumstances only after a binding declaration of enforceability, the application for annulment is inadmissible (section 1059 para. 3 sentence 4 ZPO). In this case, the only remedy is an action for prohibition of enforcement and disgorgement of the award and the exequatur decision pursuant to section 826 BGB before the Court of Appeal.   As already stated above, an unconscionably obtained foreign arbitral award may not be recognized and declared enforceable by German courts. If the defrauded party becomes aware of the unconscionable circumstances only after the award has been finally declared enforceable, it can likewise claim prohibition of enforcement and disgorgement of the exequatur decision pursuant to section 826 BGB before the Court of Appeal.   Even if the defrauded party can choose between the above two remedies, it is highly recommendable to have the arbitral award set aside. Otherwise, the risk remains (in particular in international commercial disputes) that the creditor may attempt to have the award recognized and declared enforceable in other countries.

Court of Appeal Cologne, 7 August 2015, 1 U 76/14