Governing Law & Jurisdiction

What does governing law & jurisdiction mean?

Governing law & jurisdiction (choice of law and place of jurisdiction) refers to the final provisions of a contract that answer two questions: which law applies (governing law) and who decides disputes (jurisdiction). The body that decides the dispute is called the forum: either a state court, determined by a jurisdiction agreement, or an arbitral tribunal. An arbitral tribunal is a private court of arbitrators whom the parties themselves appoint; it is established by an arbitration agreement.

Law and forum are legally separate questions. A German court can judge a contract under English law, an arbitral tribunal seated in Switzerland a contract under German law. The choice of law is governed by the Rome I Regulation (see governing law). For the forum, the German Code of Civil Procedure (Zivilprozessordnung, ZPO), the law of arbitration proceedings and the Brussels Ia Regulation apply, an EU regulation on the jurisdiction of courts and the recognition of judgments in the EU.

Contracts in English sometimes also separate jurisdiction, the competence of the courts of a state, and venue, the specific place of the court. In German terminology this roughly corresponds to international and local jurisdiction.

In company purchase and participation agreements, the choice of forum decides the duration, cost and confidentiality of a dispute. It also determines whether a decision can be enforced, that is, carried out with the help of the state, where the other side has assets.

Jurisdiction agreement before state courts

Purely German cases: Section 38 ZPO

A jurisdiction agreement determines which state court has jurisdiction. Before a dispute arises, it is permissible domestically under Section 38 (1) ZPO only between merchants and certain public-law bodies. A GmbH (German limited liability company) is a merchant as a commercial company. Founders who sell their company shares as natural persons are generally not. As against them, a jurisdiction agreed in advance is in principle ineffective in purely domestic German cases; the statutory places of jurisdiction remain.

Cross-border cases: Brussels Ia Regulation

If the parties choose the courts of an EU member state, Article 25 of the Brussels Ia Regulation applies, irrespective of the parties' domicile and subject to special protective rules for consumers and employees. Unlike Section 38 ZPO, Article 25 does not require the parties to be merchants. The agreement requires written form or an equivalent form; an email is sufficient. In case of doubt, the chosen court has exclusive jurisdiction, and other courts are then excluded.

Exclusive statutory jurisdictions cannot be changed by agreement. This applies to actions on the validity of resolutions of the organs of a company, for example the shareholders' meeting. Under Article 24 No. 2 of the Regulation, they belong before the courts of the state of the registered seat, for a German GmbH therefore before German courts.

Arbitration agreement under Sections 1025 et seq. ZPO

With an arbitration agreement (Section 1029 ZPO), the parties transfer the decision to a private arbitral tribunal. If the seat of the proceedings is in Germany, Sections 1025 et seq. ZPO apply. Any claim of a financial nature can be arbitrated, that is, transferred to an arbitral tribunal (Section 1030 ZPO). If a party nevertheless brings an action before a state court, the court dismisses it as inadmissible. The prerequisite is that the other side objects to this before the start of the oral hearing on the merits (Section 1032 (1) ZPO).

The form is governed by Section 1031 ZPO. Where a consumer is involved, that is, a private individual who is not acting commercially or professionally, stricter rules apply. The arbitration agreement must then be in a separate document personally signed by the parties, unless it is notarially recorded (Section 1031 (5) ZPO). Whether founders who sell their shares count as consumers is not always clear. Because purchase agreements for GmbH shares are notarially recorded anyway, this rarely causes difficulties there.

Institutional proceedings under the arbitration rules of the German Arbitration Institute (Deutsche Institution für Schiedsgerichtsbarkeit) or, internationally, of the International Chamber of Commerce in Paris are widespread. Disputes over the validity of shareholder resolutions of a GmbH (Beschlussmängelstreitigkeiten) can be arbitrated only if the arbitration clause meets particular requirements of the case law. These include above all the consent of all shareholders to the clause and their information and participation in the proceedings.

Arbitral tribunal or state court

• Instances: The arbitral award has the same effect between the parties as a final judgment (Section 1055 ZPO). There is no appeal; it can be set aside only on narrowly limited grounds (Section 1059 ZPO). Before state courts, up to three instances are possible, for example regional court (Landgericht), higher regional court (Oberlandesgericht) and Federal Court of Justice (Bundesgerichtshof).
• Costs: The parties bear the fees of the arbitrators and the charges of the institution, which usually depend on the amount in dispute.
• Confidentiality: Hearings before state courts are public, arbitration proceedings are not. A further duty of confidentiality follows only from the arbitration rules or an express agreement.
• Expertise: The parties can appoint arbitrators with experience of company acquisitions or the sector concerned. Before state courts, by contrast, whoever is next under the court's internal allocation of cases decides.

Irrespective of the forum, interim relief before state courts remains possible (Section 1033 ZPO), that is, an urgent procedure, for example to provisionally secure assets. Valuation questions are often transferred by purchase agreements to an expert determiner (Schiedsgutachter), an expert who makes binding findings on individual figures only. This concerns, for example, the reference-date settlement for completion accounts or the calculation of an earn-out. Its determination is in principle binding unless it is manifestly incorrect (Sections 317 and 319 of the German Civil Code, BGB).

Enforceability of the decision

A judgment from an EU member state is enforced in the other member states without the need for a separate declaration of enforceability (Article 39 Brussels Ia Regulation). Outside the EU, recognition depends on treaties and on the law of the state of enforcement. Since the United Kingdom left the EU, this also applies to judgments of English courts. Enforcing a German judgment in the USA or a US judgment in Germany is possible but involves effort and uncertainty.

Arbitral awards are recognised and enforced in most states of the world under the New York Convention of 1958. In Germany, the higher regional court declares them enforceable (Sections 1060 to 1062 ZPO). If the other side has its assets outside the EU, this often speaks in favour of arbitration.

Practical example: arbitration in a sale to a US acquirer

Three founders resident in Germany sell their company shares in a GmbH to an acquiring company seated in the USA, which has no significant assets in the EU. The acquirer's draft provides for New York law and the courts in New York.

• Law: After negotiation, German law applies, particularly since the assignment is notarially recorded in Germany anyway.
• State courts: A German judgment on deferred purchase price portions, that is, payments that fall due only after completion, would have to be recognised in the USA. A New York judgment on warranty claims would conversely have to be recognised in Germany. Both would be protracted and uncertain in outcome.
• Solution: The parties agree on institutional arbitration seated in Düsseldorf, three arbitrators and English as the language of the proceedings.
• Enforcement: In the USA, the arbitral award is recognised under the New York Convention; in Germany, the higher regional court declares it enforceable under Section 1060 ZPO.
• Form: Because the purchase agreement is notarially recorded, the clause in the contract itself suffices, even if the founders count as consumers.

What was decisive here was not the question of which law applies but where a claim can be enforced. For the founders, arbitration secures the deferred purchase price portions, because the award is enforceable where the acquirer has its assets. The higher costs of the proceedings are set against a claim that might otherwise exist only on paper.

Distinctions: governing law, expert determination and mediation

• Governing law: only the choice of law. It answers under which law a decision is made, not who decides.
• Expert determination (Schiedsgutachten): binding determination of individual facts or values by an expert, not a ruling on the entire dispute.
• Mediation: facilitation by a neutral third party without a decision of its own. The parties agree among themselves or not at all; a mediation stage is often placed before arbitration or court proceedings.
• Agent for service of process: recipient of declarations and documents for a party abroad, regulated in the notices clause.

Common mistakes

• Law and forum not aligned. A court that has to apply foreign law usually obtains expert opinions on it; this costs time and money.
• Jurisdiction clause with non-merchants. In purely domestic German contracts with founders as natural persons, a jurisdiction agreed in advance is in principle ineffective.
• Contradictory clauses. If a clause provides for both state courts and an arbitral tribunal or names an institution imprecisely, the dispute begins with the question of the forum.
• Inconsistent dispute resolution. If purchase agreement, shareholders' agreement and ancillary agreements provide for different forums, parallel proceedings over the same facts threaten.

Frequently asked questions

What is the difference between governing law and jurisdiction?

Governing law determines under which law a contract is judged, jurisdiction which court or arbitral tribunal decides in the event of a dispute. Both questions are agreed separately and are usually in the same final provision.

Is arbitration faster than court proceedings?

Often yes, above all because there is no chain of appeal. How long the proceedings themselves take depends on the subject matter of the dispute and the conduct of the parties.

Is arbitration more expensive than court proceedings?

In the first instance, generally yes, because the parties pay arbitrators and institution. Across several instances, the difference may narrow.

Can an arbitral award be appealed?

No. All that is possible is an application to set aside before the higher regional court, based on narrowly limited grounds such as an invalid arbitration agreement or a violation of public policy.

Can a German GmbH agree a place of jurisdiction abroad with investors?

In principle yes. Actions against resolutions of its shareholders' meeting remain with the German courts, however, unless an effective arbitration clause provides otherwise.

The Roemer Capital view

If the other side is seated abroad, Roemer Capital raises dispute resolution already in the letter of intent (LOI) or term sheet. It helps determine what warranties, indemnities and deferred purchase price payments are worth, because a claim counts only for as much as can be enforced. The drafting of the clause is taken over by the client's law firm.

Roemer Capital contributes the economic view: where the other side has assets and how large possible claims are in relation to the costs of proceedings. This also includes the question of which valuation questions are better decided by an expert determiner than by an arbitral tribunal.