Defence contract disputes and risk allocation in Germany

Disputes and risk allocation

How are disputes between the government and defence contractor resolved?

The standard contract terms of the German military and other German security agencies do not contain arbitration clauses. Disputes between the government and defence contractors are therefore generally resolved in civil court.

To what extent is alternative dispute resolution used to resolve conflicts? What is typical for this jurisdiction?

For smaller contracts, the German military will usually not deviate from its standard terms; thus, alternative dispute resolution may only be agreed on an ad hoc basis. For high-volume contracts, on the other hand, the military may agree to arbitration clauses on a case-by-case basis, depending on the circumstances. In subcontractor contracts, arbitration clauses are more common, if compatible with security requirements. For international contracts, the ICC, UNCITRAL, LCIA and Swiss arbitration rules are widely accepted.

What limits exist on the government’s ability to indemnify the contractor in this jurisdiction and must the contractor indemnify the government in a defence procurement?

Under German law, the government - as any private principal - must indemnify the contractor for damages arising from a breach of contract by the government, provided that damages are reasonably and foreseeably caused by the breach. Vice versa, the contractor must indemnify the government for such damages arising from a breach by the contractor.

Can the government agree to limit the contractor’s liability under the contract? Are there limits to the contractor’s potential recovery against the government for breach?

The government is free to negotiate and accept a limitation of liability of the contractor. There are no statutory or regulatory limits to the contractor’s potential recovery against the government.

Is there risk of non-payment when the government enters into a contract but does not ensure there are adequate funds to meet the contractual obligations?

Under German law, public contracting authorities - as any private principal - are bound by their contracts regardless of whether adequate funds are available. Furthermore, under German law, neither the federal state nor the regional states can go bankrupt. A contractor may take legal action against the government for default and enforce a judgment against the government at any time. Thus, there is no legal risk of non-payment.

Under what circumstances must a contractor provide a parent guarantee?

Generally, a contractor only has to provide a parent guarantee if the contractor itself does not meet the minimum requirements of financial and economic standing set by the government for the particular contract. This will often be the case with newly formed companies or, in particular, SPVs. In many cases, the government will also accept a limited bank guarantee as security instead of a parent guarantee.