Contract formation

Good faith in negotiating

Is there an obligation to use good faith when negotiating a contract?

Yes. Good faith is regulated in section 242 of the German Civil Code (BGB). It is a fundamental principle under German law. It establishes the obligation on both parties in a contract to reliably and sincerely perform their obligations, taking customary practice into consideration. However, unless there is a violation of specific rules of law of the BGB or the German Commercial Code (HGB), it is rather hard to enforce a party’s right that is established only on the general rule of section 242 of the BGB.

The principle of good faith is specified, for example, in section 138 of the BGB (no legal transaction contrary to public policy; no usury) and in section 307 et seq of the BGB (no unreasonable disadvantage to the other party in general terms and conditions).

The principle of good faith also establishes pre-contractual rights and obligations on the parties (sections 311(2) and 241(2), BGB). A party in negotiations may demand compensation for the culpable estoppel (abandonment) of contractual negotiations by the other party if:

  • the other party has caused it to have particular confidence that the future contract will be concluded;
  • the party claiming compensation has incurred expenses in expectation of the contract; and
  • the other party has stopped the negotiations very unexpectedly and without a material reason for doing so.

Moreover, the principle of good faith requires, for example, that the parties in contract negotiations clarify circumstances to the other party that are of great importance with respect to conclusion of the contract.

‘Battle of the forms’ disputes

How are ‘battle of the forms’ disputes resolved in your jurisdiction?

In principle, a valid contract under German law requires two corresponding declarations of intent. Offer and acceptance do not need to be declared expressly. A contract can also be concluded by implied behaviour (eg, supply of the ordered products).

If more than two parties are involved - which may for example be the case when corporate groups enter into contracts with suppliers - each party that wishes to become party to the contract has to issue a corresponding declaration of intent.

Pursuant to section 150(2) of the BGB, an acceptance containing expansions, restrictions or other alterations is considered to be a new offer and therefore does not result in a contract unless it is - without limitation - accepted by the addressee in turn. The addressee may, however, accept such modification tacitly or impliedly; for instance when accepting the supplied goods.

In commerce, silence may, in very exceptional circumstances, also result in the conclusion of a contract. Where an offer is made to a merchant whose business includes solicitation or conclusion of business transactions for others, and such offer is from someone with whom the merchant has a business relationship and concerns solicitation or conclusion of such transactions on behalf of the offeror, the merchant is obliged to reply immediately. Otherwise silence will be deemed to be acceptance of the offer pursuant to section 362(1), sentence 1 of the HGB. Pursuant to section 346 of the HGB, the German courts have developed the principle of the commercial letter of confirmation. It only applies in commercial interactions and is aimed at accelerating the commercial intercourse. In cases where the addressee of the commercial letter of confirmation remains silent, it results in a legal presumption that a contract with the content of the confirmation letter has been concluded between the sender and addressee, irrespective of whether or not the parties have finally concluded the contract before.

A question of high practical importance with regard to the ‘battle of the forms’ is which standard terms apply where both parties in a contract claim that their standard terms and conditions are part of the contract. The party making the offer generally attaches its standard terms and conditions when making the offer. The party accepting the offer often also attaches - or at least makes reference to - its standard terms and conditions when either declaring acceptance or delivering the purchased goods or services. In cases where the parties start to perform their contractual obligations despite the conflicting terms, the standard terms and conditions of the parties are valid only to the extent that they do not conflict but correspond with each other. With regard to the rest, there is a lack of agreement. Pursuant to section 306 of the BGB, the conflicting clauses are replaced by the statutory provisions of the BGB or the HGB.

It is important to know that lack of agreement is not necessarily an obstacle to the creation of the contract if the parties start implementing it by mutual consent and, by doing so, show that they do not regard the lack of conformity to be material.

Language requirements

Is there a legal requirement to draft the contract in the local language?

No, the parties are free to choose the law governing their contract as well as the language.

The language in German courts, however, is German. Where the contract documents or correspondence is introduced in the court proceedings by one of the parties, the documents need to be translated. This is different in arbitral proceedings under German law, which may be held in English or any other language agreed by the parties.

Online contracts

Is it possible to agree a B2B contract online?

Yes, the principle of freedom of contract that dominates German law provides that contracts may in principle be concluded without observing any form requirement. Therefore, in general, business-to-business (B2B) contracts can, for example, be concluded orally, via email or fax, online or in written form.

Only in limited specified cases, the law requires that the parties use a specific form. This applies, in particular, where real estate is sold (contracts on plots of land, section 311b(1), sentence 1, BGB), company shares are transferred (section 15(3), Limited Liability Companies Act (GmbH)) or a donation is promised (section 518(1), BGB).

Statutory controls and implied terms

Controls on freedom to agree terms

Are there any statutory or other controls on parties’ freedom to agree terms in contracts between commercial parties in your jurisdiction?

Yes, the principle of freedom of contract is limited by some important restrictions:

The law on general terms and conditions, section 305 et seq, BGB

Consumer contracts, as well as B2B agreements, are subject to the term control established by the law on standard terms and conditions. The German concept of the review of standard terms and conditions (‘term control’ or ‘test of reasonableness’) goes beyond what is established under Directive 93/13/EEC on unfair terms in consumer contracts and is therefore particularly strict.

In order to evaluate whether a clause in a contract is considered an unreasonable disadvantage for the other party, German law has created a non-exhaustive list of prohibited terms (sections 308 and 309, BGB). Moreover, section 307 of the BGB provides a fallback rule for cases in which sections 308 and 309 of the BGB are not applicable, and which is particularly relevant in B2B cases. Where a contractual clause is a standard term (ie, designed for multiple use) and it fails the test of reasonableness because it is found to be an unreasonable disadvantage to the other party, such clause in a contract is void and is replaced by statutory law. The law on general terms and conditions is mandatory and cannot be waived by the parties.

Violation of a statutory prohibition, section 134, BGB

Legal transactions that violate a statutory prohibition are void unless the statute leads to a different conclusion (section 134, BGB). Section 134 of the BGB limits the freedom of contract, as statutory prohibitions are not at the disposal of the parties. For example, a contract in which the parties agree on insurance fraud pursuant to section 265(1) of the German Criminal Code (StGB) is void.

Legal Transaction Contrary to Public Policy, section 138, BGB

Pursuant to section 138(1) of the BGB, a legal transaction that violates bonos mores (public policy) is void. Section 138 of the BGB restrains the freedom of contract insofar as the legal system does not accept contracts whose content is contrary to public policy. What is to be understood as ‘public policy’ is in constant need of interpretation and judicial clarification. Under section 138 of the BGB, usury or economically oppressive contracts will be ineffective.

Prohibition of agreements in restraint of competition

Contracts that are violating antitrust law might result in the ineffectiveness of parts of the contract or the entire agreement. Especially in the case of distribution agreements and trade agreements (eg, original equipment manufacturer agreements, tooling agreements or framework agreements) that contain exclusive purchase obligations, exclusive distribution rights, selective distribution or non-competition clauses, the Act against Restraints of Competition and article 101 of the Treaty on the Functioning of the European Union need to be observed by the parties.

Standard form contracts

Are standard form contracts treated differently?

Pre-formulated standard form contracts are generally governed by the law on standard terms and conditions that is regulated in section 305 et seq of the BGB. Individually agreed terms are not subject to the law of standard terms and conditions and therefore do not fall under the ‘term control’.

The law on standard terms and conditions and its ‘term control’ applies not only to fine-printed standard terms but also to any contract clause that was designed for repeated use. Clauses and terms drafted by a trade association, legal counsel or the company lawyer also fulfil this requirement, if imposed on the contract partner by the other party.

Even contracts in a B2B context that were negotiated by the parties can still - at least partially - fall under the law of standard terms and conditions, at least insofar as certain clauses were not seriously negotiated because the party providing the draft was effectively not willing to debate about the clause.

Service and work descriptions, specifications and price terms (as long as they are transparent) are not subject to the ‘term control’.

Implied terms

What terms are implied by law into the contract? Is it possible to exclude these in a commercial relationship?

German law establishes warranty terms for purchase agreements (section 437, BGB) and for contracts for work, such as, for example, construction contracts (section 634, BGB). In purchase agreements, the seller warrants for a period of two years (from delivery) that the product is free from defects. In contracts for work, the limitation period for defects is, in principle, two years but five years in the case of a building.

Where the seller hands over a defective good, the buyer may initially demand repair or replacement. The seller must - also in a B2B context - bear all expenses required for the purpose of rectification (cure of defect), in particular, transport, workmen’s travel, work and materials costs, costs for removal and installation (including re-installation) (section 439(2) and (3), BGB).

The exclusion or restriction of warranty is possible under German law only to a very limited extent. It is possible to reduce the limitation period in standard terms from two to one year. The limitation period for defects in works for a building (which is five years) cannot be reduced in standard terms.

Vienna Convention

Is your jurisdiction a signatory to the United Nations Convention on Contracts for the International Sale of Goods (the Vienna Convention)?

Yes. The Vienna Convention is consequently part of German law and therefore applicable where the parties chose German law unless they exclude the Vienna Convention in their choice of law clause.

Good faith in entering and peforming

Is there an obligation to use good faith when entering and performing a contract?

Yes, as described in question 1, either party has to take account of the rights, legal interests and other interests of the other party during performance of the contract.

Limiting liability

Prohibition on exclusions and limitations

What liabilities cannot be excluded or limited by a supplier in a contract?

In contracts that are agreed individually between the parties, the parties may exclude any liability except their liability for intentional behaviour (section 276(3), BGB).

As most contracts, however, fall within the scope of the BGB’s provisions on general terms and conditions, the exclusion of liability is subject to further comprehensive restrictions. Neither party may exclude its liability with regard to:

  • intentional or grossly negligent breaches of obligations;
  • a violation of material contractual obligations (The Federal Court of Justice (BGH) has ruled that these material contractual obligations are core obligations for the fulfilment of the contract on which the customer may rely);
  • personal injury or death;
  • default, if delivery by a fixed date is agreed; or
  • liability under mandatory statutory provisions - in particular, the Product Liability Act.
Financial caps

Are there any statutory controls on using financial caps to limit liability for breach of contract?

Not in individually agreed contracts.

In contracts that fall within the scope of the BGB’s provisions on general terms and conditions and are therefore subject to ‘term control’, a cap must not unreasonably discriminate against the other party, which would be the case where the limitation of liability results in a liability that is (far) below what is typically foreseeable.

Indemnities

Are there any statutory controls on indemnities used to cover liability risks in contracts?

There are no rules under German law that govern indemnification. However, indemnifications are often used in international agreements, also when German parties are involved or German law governs such agreements.

It can be assumed that, in standard terms and conditions, an indemnification that is highly detrimental to the other party is likely to be void

Liquidated damages

Are liquidated damages clauses enforceable and commonly used in your jurisdiction?

Yes, liquidated damages or contractual penalties are customary and enforceable under German law.

A contractual penalty clause not only supports the enforcement of the contractual obligation, it also facilitates the enforcement of damage compensation at the same time. In fact, a contractual penalty is, in principle, not required to claim compensation from the party being in breach. However, in practice, it is often not possible for the other party to prove that a violation of a specific contractual obligation (eg, a confidentiality obligation) has caused damage.

Where a contractual penalty clause is subject to the law on standard terms and conditions pursuant to section 307 of the BGB (which is generally the case), it must fulfil the following requirements:

  • The contractual penalty clause must determine a fair and appropriate amount to be paid in the case of a violation of the confidentiality agreement.
  • A contractual penalty clause must establish a penalty payment only where the contractual obligation has been violated culpably.
  • Both damages and contractual penalties may not be demanded simultaneously.
  • Liquidated damages need to be capped, where the penalty clause establishes an ongoing (eg, daily or weekly) payment obligation on the party in breach of its obligation. Courts have considered 5 per cent of the contract value as suitable.

Payment terms

Statutory time limits on payments

Are there statutory time limits for paying invoices? Is it possible to agree a different payment period?

In general, invoices must be paid immediately, unless a different payment term was agreed (section 271(1), BGB).

Where a payment date is agreed in general terms and conditions, a provision reserving a period of more than 30 days for the debtor to pay after receipt of the creditor’s performance is invalid (sections 308(1)(a), 310(1), BGB). In individual agreements (not subject to the law of standard terms and conditions), the foregoing applies with a period of 60 days (section 271(a), BGB).

Late payment interest

Is statutory interest charged on late payments? Is it possible to agree a different rate of interest?

German law provides statutory rules on payment default. If payment is not made within 30 days of the due date, the debtor will automatically be in default (section 286(3), BGB). The default interest rates are regulated in section 288 of the BGB.

Pursuant to section 288 of the BGB, there is a maximum interest rate of 5 percentage points above the base rate for business-to-consumer (B2C) transactions and 9 percentage points above base rate for B2B transactions.

The parties may deviate from the default interest rates. Where the parties’ deviating agreement is part of standard terms and conditions, section 309(5) of the BGB must be observed. The agreement of an interest rate higher than stipulated in section 288 of the BGB will be invalid if the agreed default interest exceeds the damage to be expected in the ordinary course of events (section 309(5)(a), BGB).

Civil penalties

What are the civil penalties for failing to comply with statutory interest rate or late payment of invoices?

This may lead to claims for damages and, after setting out a reasonable deadline for payments, may result in the other party’s right to terminate or withdraw from the contract.

Termination

Implied terms

Do special rules apply to termination of a supply contract that will be implied by law into a contract? Can these terms be excluded or limited by including appropriate language in the contract?

Yes, German law provides specific termination options; some of them are mandatory and may not be waived by the parties. In principle, the parties have wide discretion in determining the preconditions of termination and revocation and may in particular go beyond the statutory rights. German law provides, inter alia, the following termination rights:

Extraordinary notice for cause

Section 314 of the BGB is the general rule when it comes to extraordinary notice for cause. For specific types of contract, German law provides specific rules on extraordinary notice for cause (eg, section 89a, HGB; section 543, BGB; section 626, BGB). Section 314 of the BGB establishes the opportunity for either party of an ongoing continuing obligation to terminate the contract for cause (ie, a compelling reason) without any notice period. This right of termination may not be excluded by agreement between the parties.

Ordinary notice in commercial agency and distribution agreements

Section 89 of the HGB establishes a mandatory option to terminate commercial agency agreements if they were entered into for an indefinite period of time. Depending on the duration of the agency relationship, the notice period is between one and six months. This right to terminate without cause applies by analogy to distributorship and franchise agreements, if the distributor (franchisee) is embedded in the distribution system of the manufacturer, comparable to a commercial agent.

Extraordinary termination with notice period

If the law does not set forth specific fallback rules (eg, as is the case with supply agreements or framework agreements), the Federal Court of Justice has - under specific preconditions - acknowledged a non-written right to terminate an ongoing continuing obligation with an adequate notice period (roughly six to 12 months). This unwritten right to terminate the agreement extraordinarily is given where:

  • the parties have concluded an unlimited ongoing obligation;
  • no other right to terminate the contractual relationship applies; and
  • the parties did not expressly exclude the right to terminate the ongoing obligation ordinarily.
Rescission in purchase contracts and contracts for work

Under specific statutory reasons, the parties are entitled to rescind a purchase contract or a contract for work, pursuant to sections 323, 324, 326(5) of the BGB. This is the case, in particular, where a party does not perform its duties under the contract or a party is in breach of contractual duties despite a time limit for performance being set. Performances received and payments taken have to be returned in such a case.

Notice period

If a contract does not include a notice period to terminate a contract, how is it calculated?

There is no general rule establishing notice periods. It depends on the contract type and the specific circumstances of the case.

Automatic termination on insolvency

Will a commercial contract terminate automatically on insolvency of the other party?

According to section 116 of the German Insolvency Code (InsO), business management contracts (section 675, BGB) terminate automatically as of the opening of the insolvency proceedings over the assets of the insolvent principal. The rationale behind this is that the insolvency administrator is the only person authorised to administer the insolvency estate. Therefore, in particular commercial agency agreements, forwarding agreements and commission agency agreements (not franchise, distribution or freight agreements) expire automatically by the opening of the insolvency proceedings over the assets of the principal or shipper.

Apart from the exception of section 116 of the InsO, generally commercial contracts do not automatically end by the opening of the insolvency proceedings. However, in commercial contracts such as supply agreements, framework agreements or OEM agreements, the parties commonly agree on insolvency-related termination rights entitling the party to declare extraordinary notice of termination in case the other party becomes insolvent. It needs to be observed that the Federal Court of Justice has ruled that insolvency-related termination clauses in long-term agreements are invalid as far as they preclude the insolvency administrator’s discretion to continue a contract under section 103 et seq of the InsO. Recently, German courts tend to be very strict with regard to such termination clauses and also tend to declare termination clauses ineffective that have an ‘insolvency connection’.

Termination for financial distress

Are there restrictions on terminating a contract if the other party is in financial distress?

No general restriction exists on terminating a contract if the other party is in financial distress with the only exception of the termination of lease contracts after application for the opening of insolvency proceedings according to section 112 of the InsO.

There is also no statutory law that generally authorises a party to terminate the contract where the other party is in financial distress. A party may, however, be able to terminate the contract in case of a continued violation of the contract where it is unacceptable for a party to be bound to the contract any longer; which may, for instance, be the case where the other party is in delay of payments or in the case of a material deterioration of the other party’s financial situation after conclusion of the contract. Any contract clauses that concede a right to terminate the contract due to financial distress need to be reviewed on a case-by-case basis.

Force majeure

Is force majeure recognised in your jurisdiction? What are the consequences of a force majeure event?

Yes, but only to a very limited extent. Pursuant to section 206 of the BGB, limitation is suspended for as long as, within the last six months of the limitation period, a party is prevented by force majeure from prosecuting its claims. Moreover, a party’s claim for performance is excluded to the extent that performance is completely impossible for the other party (section 275, BGB).

It is common and permitted to agree on comprehensive force majeure clauses in contracts that are regulating long-term relationships, such as framework and supply agreements, OEM agreements or distributorship agreements.

Subcontracting, assignment and third-party rights

Subcontracting without consent

May a supplier subcontract its obligations under the contract without seeking consent from the other party?

In principle, yes. Section 267 of the BGB stipulates the freedom of a party to use subcontractors unless a contractual prohibition is in place and with the exceptions of severely personal services (eg, services pursuant to section 613, BGB, contracts regarding expert opinions). The supplier, however, remains fully liable to the contract partner for the proper performance of its contractual obligation (section 278, BGB).

Where the parties have explicitly excluded subcontracting or subcontracting is subject to the customer’s prior approval, the general principle of section 267 of the BGB is also ruptured.

Statutory rules

Are there any statutory rules that apply to subcontracting in your jurisdiction?

Yes, the principles are regulated in sections 267 and 613 of the BGB. Moreover, sections 278 and 831 of the BGB, for instance, govern the question of the liability of the party for the actions of its subcontractor. As a principle, contracts establish rights and obligations only with effect between the contract parties, unless the contract expressly unfolds protective character on behalf of third parties as might be the case in section 328 of the BGB.

Assignment of rights and obligations

May a party assign its rights and obligations under the contract without seeking the other party’s consent?

Rights can be assigned to a third party also without the prior consent of the contract partner (section 398, BGB) unless there is a contractual clause in place demanding such consent. However, according to section 354a of the HGB, a prohibition of assignment in B2B cases is invalid where (i) two merchants agree on (ii) the prohibition of assignment for outstanding debts (not goods). The rationale behind this rule is to facilitate financing for small and medium-sized companies

What statutory controls apply to the assignment of rights or obligations under a supply contract?

Pursuant to section 399 of the BGB, claim may not be assigned if the performance cannot be made to a person other than the original obligee without a change of its contents or if the assignment is excluded by agreement between the parties. Section 354a, HGB remains unaffected.

Enforcement by third party

How may a third party enforce a term of the contract?

In principle, a third party cannot require performance of a contract concluded between two other parties. Likewise it is not possible to conclude a contact to the detriment of a third party, without the third party’s consent.

Only in the case where a contract for the benefit of a third party is concluded pursuant to section 328 of the BGB, such third party is entitled to benefit and even claim for performance. This, for example, is the case in supply agreements concluded between the holding company of a corporate group and its supplier that empowers all affiliates of the group to purchase goods from the supplier under the supply agreement.

Disputes

Limitation periods

What are the limitation periods for breach of contract claims? Is it possible to agree a shorter limitation period?

Pursuant to section 195 of the BGB, the standard limitation period is three years, although certain claims lapse after 10 years (eg, transfer of ownership of land, section 196, BGB) or 30 years (eg, claims that have been declared final and absolute, enforceable settlements or judgments, section 197, BGB).

The standard limitation period commences at the end of the year in which (i) the claim arises and (ii) the creditor obtains knowledge of the circumstances giving rise to the claim and of the identity of the obligor, or would have obtained such knowledge had he or she not shown gross negligence. However, irrespective of knowledge or a grossly negligent lack of the creditor’s knowledge, claims lapse 10 years after they arose (section 199(3), BGB).

The special limitation period for defects in purchase agreements is two years from delivery. In contracts for work, the limitation period for defects is, in principle, two years but five years in the case of a building. A reduction or extension of these limitation periods is only possible in a few circumstances.

However, in principle it is - to a large extent - possible to agree on shorter or longer limitation periods.

Choice-of-law clauses

Do your courts recognise and respect choice-of-law clauses stipulating a foreign law?

Yes, pursuant to article 3(1) of the Rome I Regulation, choice-of-law clauses are in principle admissible in B2B contracts and therefore fully recognised by German courts. However, the conflict-of-law public policy exception in article 9 of the Rome I Regulation might overrule the law chosen by the parties, if that foreign law or a specific provision of that foreign law is contrary to fundamental principles of the national law. Moreover, article 3(3) can limit the party’s choice-of-law.

Do your courts recognise and respect choice-of-jurisdiction clauses stipulating a foreign jurisdiction?

Yes, if the preconditions of article 25 of the Brussels I Regulation on Jurisdiction and the Recognition and Enforcement of Judgments in Civil and Commercial Matters of 12 December 2012 are observed, the court or the courts of that member state shall have exclusive jurisdiction.

Efficiency of local legal system

How efficient and cost-effective is the local legal system in dealing with commercial disputes?

Compared with the court system of other countries, in particular, with regard to common law countries, the German court system is rather inexpensive, as there is no pre-trial discovery and the court costs are reasonable. Moreover, the German court system is independent, reliable, of high quality and efficient.

The duration of court proceedings in Germany is reasonable compared with other countries. Nevertheless, complex legal disputes can last up to two or three years in the first instance. Commonly, however, it would take between six and 12 months for a judgment in the first instance.

New York Convention

Is your jurisdiction a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards? Which arbitration rules are commonly used in your jurisdiction?

Yes. Germany is a signatory to the New York Convention.

The most common arbitration rules and arbitration institutions are the German Institute for Arbitration and the International Chamber of Commerce.

Remedies

Available remedies

What remedies may a court or other adjudicator grant? Are punitive damages awarded for a breach of contract claim in your jurisdiction?

Courts have the power to order a defendant to fulfil its contractual obligations to perform, to cease and desist from specific conduct, or to pay damages.

Punitive damages are not awarded and foreign judgments awarding punitive damages are, in principle, not enforceable in Germany. Damages, of course, are awarded insofar as they compensate the loss incurred.

Update and trends

Recent developments

Are there any other current developments or emerging trends that should be noted?

Current developments33 Are there any other current developments or emerging trends that should be noted?

The German legal system - in particular, the Code of Civil Procedure- does not provide for class actions. However, a change in this field of law can clearly be recognised owing to numerous high-profile commercial cases in the past few years that require an instrument to bundle claims of damaged consumers. In particular, cartel damage claims and thousands of ‘diesel’ claims that were recently filed against Volkswagen have induced the German legislator to pass a law allowing multiple aggrieved individuals to file for a petition for determination in a model proceeding. Where consumer protection organisations file claims of at least 10 consumers concerned, the higher regional courts have the competence to issue a decision on determination in a model proceeding. It might be reasonably assumed that this new procedural instrument will fundamentally change or at least influence commercial litigation in the years to come.