Arbitration and the Choice of Law
One remarkable benefit of arbitration over litigation is the ability of the parties to cherry-pick the law applicable to the dispute. This gives parties the ability to select favorable or eliminate unfavorable individual provisions of the law that will govern the arbitration. Recently, the German Federal Court of Justice ("BGH") approved an arbitration clause that, while choosing German law, opted out of specific provisions of German contract law relating to standard terms (Judgment of 9 January 2025, docket no. I ZB 48/24).
The ability to select individual legal provisions is one of the many reasons why arbitration proceedings have traditionally been the most frequently chosen dispute resolution mechanism, particularly for complex international M&A transactions. For example, large German corporations often consider German contract law on standard business terms to be too rigid. Infamously, German courts may strike out standard terms which they consider to be "unfair" by applying enhanced scrutiny to the contract, regardless of the size of the transaction or the sophistication of the contracting parties. While there is an ongoing policy debate regarding reforming German contract law, this debate has not yielded any tangible results. In July 2024, the Bundestag rejected the CDU's and CSU's proposal to ease contract law for large businesses before the new German Commercial Courts.[1] The newly formed Merz administration agreed to take this step.[2]
Scope for selecting the choice of law
For German courts, the Rome I Regulation governs the choice of law for contracts such as international M&A transactions. Under Article 3(1) of the Rome I Regulation, the parties can choose the law applicable to their contract. However, they cannot cherry-pick parts of a specific legal system, e.g., German contract law, without rules relating to standard terms. Furthermore, there is a risk under Article 3(3) that German courts consider a dispute predominantly domestic. In such a case, they will apply mandatory rules of German contract law regardless of the parties' choice for another jurisdiction.
Such restrictions do not exist in an arbitration proceeding governed by the German Arbitration Institute ("DIS"). Under Article 24.1 of the DIS Rules, the "parties may agree upon the rules to be applied to the merits of the dispute". Likewise, Section 1051(1) of the German Code of Civil Procedure states that the arbitral tribunal applies "the legislative provisions the parties have designated as being applicable to the substance of the legal dispute".
According to most scholars and the recent decision by the German Federal Court of Justice, these provisions grant parties the ability to opt out of selected parts of the law, such as the German provisions on standard terms, even if the entire dispute relates to Germany. In practice, this means that when drafting the arbitration clause parties can specify the substantive law that the arbitration tribunal should apply in any future dispute. Consequently, arbitrators should strictly adhere to the parties' agreement over which rules govern (and do not govern) the transaction.
Respecting the choice of law
Neither the tribunal nor the state courts in any subsequent proceedings should thwart the parties' choice of law in the arbitral proceedings. For example, if the parties have opted out of mandatory contract law, the parties cannot challenge the arbitral award later before state courts for violation of mandatory contract law. That is because those rules are not part of the public policy in the meaning of Section 1059(2)(2)(b) of the German Code of Civil Procedure. On the other hand, if the arbitral tribunal were to apply mandatory contract law against the parties' choice, state courts should nullify the arbitral award for violating the parties' arbitral agreement.
In sum, arbitration offers a unique freedom of choice for parties to tailor-make their dispute resolution mechanism. This is one reason arbitration often remains the favorable choice for parties over traditional litigation and the newly established Commercial Courts.
[1] https://dserver.bundestag.de/btd/20/121/2012116.pdf.
[2] Coalition Agreement 2025, p. 87.
