The court ruled that the US social media giant was not obliged to actively search out and delete defamatory posts, like those that had falsely linked the claimant to Islamist attacks and violent crimes.
Anas Modamani, 19, had sought an injunction demanding that the company, represented by Facebook Ireland Limited, stop the spread of such slanderous fake news, which have been shared countless times.
Modamani and his lawyer Chan-jo Jun had demanded that Facebook actively search out and take down all libellous posts using the famous selfie images -- not just those they had flagged to the company.
They argued Facebook could use its algorithms to automatically identify them, just as it does to take down copyrighted music or images with nudity.
The court however judged that Facebook had not "claimed ownership" of the posts in question -- suggesting primary responsibility lies with those who wrote and posted them.
In cases of "serious personal injury", it was justified to demand an "increased search effort" by Facebook, the court in the southern city of Wurzburg found.
However, it also said it was unclear whether Facebook could reasonably conduct such pro-active searches "without major technical hurdles".
The court said this question may have to be settled by another court hearing that could ask IT experts to testify.
- 'Difficult situation' -
Jun, the IT lawyer, declared himself "disappointed" and said he would not pursue the case further as he had himself become the target of personal threats on social media.
He also said that if German law could not prevent such online vitriol against his client, then "we need new laws".
Jun has demanded stiff fines in cases where Facebook spreads content illegal under German law, such as incitement of racial hatred, arguing that "it must become more costly to break the law".
Facebook voiced sympathy for Modamani's "difficult situation" but greeted the court's position that legal action was "not the most effective way to resolve the situation".
It said that, just as it had blocked previously reported hate posts targeting the Syrian man, "we will continue to respond to all legitimate reports by Mr Modamani's legal representatives".
A Facebook spokesman added that, "in terms of the content people share on our platform, we are continuing to comply with our obligations under German law".
- 'Xenophobic fury' -
Modamani arrived in Germany in 2015, along with a mass influx of almost 900,000 refugees and migrants.
When Merkel visited his Berlin refugee shelter in September that year, he took two selfie images with her in jubilant scenes also captured by news photographers.
Since then, those emblematic images have been reposted in different, often false, contexts, at a time when xenophobic fury flared online against Merkel's liberal stance on refugees.
Often anonymous users have cut and pasted Modamani's picture into "wanted" posters and fake reports, typically alleging that the refugee made famous by the Merkel selfie had later turned out to be a terrorist.
Other posts have falsely linked Modamani -- who is now taking German language courses and working in a fast food restaurant -- to delinquents who tried to set fire to a homeless man in Berlin last Christmas.
A surge of far-right and other hate speech on Facebook and other social media in Germany has raised political heat on the companies in recent years.
Justice Minister Heiko Maas has warned they could be punished if they do not comply with German law.
Facebook and other web giants pledged in 2015 to examine and remove within 24 hours any hateful comments spreading online, in particular over the mass influx of migrants.
This January -- in the wake of the US presidential election when Facebook was accused of helping the spread of fake news -- the company pledged measures to take down "unambiguously wrong reports" being shared on its platform.
It also said it would offer a simpler reporting process for fake news, display warnings next to statements identified as false by independent fact-checking organisations, and cut off advertising revenue to fake news sites.