Country Q&A
Germany
Stephan Rippert, Katharina Weimer, Oliver Heeder, Rene Lochmann and
Sabine Weiss, Reed Smith LLP
www.practicallaw.com/8-215-1984
GENERAL
1. To what extent does national law specifi cally regulate out-sourcing transactions?
National law does not specifi cally regulate outsourcing transac-tions. This presents challenges in drafting and concluding an agreement that satisfi es both parties’ requirements. An outsourc-ing agreement can include various different contract types regu-lated by the German Civil Code ( Bürgerliches Gesetzbuch (BGB) ), for example:
Sales contracts.
Lease contracts ( see Question 6 ). Works contracts ( see Question 23 ).
Contracts regulating the transfer of assets or shares ( see Question 3 ).
The BGB’s provisions apply to outsourcing agreements to the ex-tent that they contain aspects of these contract types. The out-sourcing agreement is a mixed-type agreement.
2. What additional regulations may be relevant on a:
Financial services outsourcing?
Business process outsourcing?
IT outsourcing?
Telecommunications outsourcing?
Public sector outsourcing?
Other outsourcing?
Financial services
The outsourcing of fi nancial services is subject to a strict regula-tory regime that takes into account clients’ and investors’ inter-ests, as well as the stability of the overall fi nancial system. The applicable law depends on the nature of the fi nancial servic-es company, as well as the operational activitiservic-es to be outsourced
( see below ). Personal information and other highly sensitive indi-vidual data are protected by:
The German Federal Data Protection Act ( Bundesdatens-chutzgesetz (BDSG) ).
The respective state laws.
The principle of banking secrecy (which the supplier must be contractually required to follow).
In relation to data protection, see Question 14 .
Outsourcing by credit and financial services institutions. Credit
and fi nancial services institutions include banks and portfolio managers. The outsourcing of operational areas that are essential for conducting banking business or providing fi nancial services to third parties is regulated. The outsourcing must not impair ( sec-tion 25a, Banking Act (Kreditwesengesetz (KWG)) ):
The orderliness of the business or services.
The managers’ ability to manage and monitor the business or services.
The German Federal Supervisory Authority’s ( Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) ) right to audit and ability to monitor the business or services.
In particular, the customer must contractually ensure that it has the required powers to give instructions to the supplier and must include the outsourced areas in its internal monitoring proce-dures.
The BaFin provided more details on these requirements in its Circular No. 11/2001 of 6 December 2001. This provides that section 25a of the KWG applies if the supplier is commissioned to perform essential activities on a permanent basis or at least for a prolonged period. In certain areas like core management func-tions, outsourcing is prohibited. Any outsourcing must:
Be based on a written contract.
Clearly defi ne the operational area to be outsourced. Follow the rules set up by the BaFin in relation to:
the process of the selection, instruction and monitor-ing of the supplier;
internal and external auditing;
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supervision, security and data protection procedures; business and banking secrecy;
the customer’s clients’ information; outsourcing to suppliers abroad.
The BaFin or authorised auditing agents must have full and unre-stricted access to the outsourced operational area at all times for inspection and auditing. The supplier must contractually agree with the customer to give the BaFin or its authorised auditing agents any information, and to provide any documents regard-ing the outsourced area that they require for their supervisory activity.
The institution must immediately notify the BaFin and the Ger-man Federal Bank ( Deutsche Bundesbank ) of both:
Its intention to outsource operational areas. The execution of this intent.
Outsourcing by investment services companies. Investment
services companies ( Wertpapierhandelsunternehmen ), such as brokers and investment traders, are subject to section 33(2) of the Securities Trading Act ( Wertpapierhandelsgesetz (WpHG) ). Its requirements are identical to the requirements of section 25a of the KWG ( see above, Outsourcing by credit and financial serv-ices institutions ).
Outsourcing by investment companies. Capital investment
com-panies ( Kapitalanlagegesellschaften ) can, subject to sections 16 of the Investment Act ( Investmentgesetz (InvG) ) and 25a of the KWG, outsource their business activities, if the outsourcing does not hinder the capital investment company from acting in the in-vestors’ interests. If the transfer concerns portfolio management, then only enterprises licensed for asset management and subject to effective public supervision can carry out the business. In ad-dition, the outsourcing must be consistent with the rules on the distribution of investments, which are regularly set by the capital investment company. The capital investment company is liable for any faults of the supplier. The tasks outsourced by an invest-ment manageinvest-ment company must be listed in the sales prospec-tus to be published in accordance with section 42 of the InvG.
Business process
None.
IT
None.
Telecommunications
In an outsourcing, the supplier must observe the secrecy of tel-ecommunications rules set out in section 88(2) of the Telecom-munications Act ( Telekommunikationsgesetz (TKG) ). In addition, specifi c data protection provisions of the TKG may replace the more general provisions of the BDSG.
Public sector
If the value of a public sector outsourcing transaction exceeds certain fi nancial thresholds, it requires an offi cial tender process regulated by the Act on Restraint of Competition ( Gesetz gegen Wettbewerbsbeschränkung (GWB) ). The Tender Procedure ( Ver-gabeordnung ), and the Contracting Rules for Awards of Public Service (VOF), of Public Works (VOB) and of Delivery (VOL) may also need to be observed.
Public procurement above certain fi nancial thresholds is also regulated by:
Directive 2004/17/EC co-ordinating the procurement pro-cedures of entities operating in the water, energy, transport and postal services sectors.
Directive 2004/18/EC on the co-ordination of procedures for awarding public works, supply and service contracts. These directives promote equal treatment between suppliers and set up a transparent awards procedure. They were implemented in Germany in October 2006.
Other
Outsourcing can be implemented in various additional areas such as human resources or facility support. These areas are also subject to general provisions of the BGB, employment laws, and data protection or other statutes, depending on the particular out-sourcing.
LEGAL STRUCTURES
3. In relation to the legal structures commonly used on an out-sourcing, please describe:
How each structure works, and its potential advantages and disadvantages.
The different supplier models used (for example, multi-sourcing, prime contractor, joint agreement and joint ventures).
Common structures
Direct and indirect outsourcing. Outsourcing deals can be
struc-tured in various ways between the parties. However, they are usu-ally structured as either:
Direct outsourcing, which involves a direct outsourcing contract between the customer and the supplier.
Indirect outsourcing (that is, there is no direct outsourcing contract between the customer and supplier), which may include a joint venture between the customer and the sup-plier, together with an outsourcing agreement between the customer and the joint venture ( see below, Joint venture or partnership ).
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Both direct and indirect outsourcings have advantages anddisad-vantages. The advantages of indirect outsourcing include: The opportunity for both parties to make use of their re-spective know-how.
The opportunity to transfer gradually the service into a joint venture or other separate entity.
The use of a vehicle to provide services also to third parties. The provision for control on a shareholder level.
The disadvantages are that the resulting level of management and risk-sharing can reduce some of the potential cost savings and delay a timely integration process. Also, in an exit scenario, the joint venture must be dissolved in addition to terminating the outsourcing agreement.
The advantages of a direct outsourcing include:
Additional joint venture or partnership agreements and so on are not necessary.
In the case of termination, there is no need to dissolve enti-ties or partnerships.
It has clear objectives (that is, for the customer to gain service quality, for the supplier to make a profi t). The disadvantages of a direct outsourcing include:
Loss of know-how. Loss of control.
No vehicle to provide services in relation to third parties. For international outsourcings, the parent companies typically enter into a framework agreement and the international services are provided by the subsidiaries in their respective countries. The subsidiaries can also become parties to the outsourcing agree-ment or enter into separate contracts under the framework out-sourcing agreement. In these cases, certain guarantees by the parent company should be considered.
Strategic outsourcing. In a strategic outsourcing, the customer
has already transferred certain services into a separate business division within its group. As the next step, the customer out-sources the division to the supplier. It can be transferred to the supplier either:
Through an asset or share deal ( see below, Asset or share deal ).
Through a joint venture between the customer and the sup-plier. Generally, after a period of three to seven years, the customer transfers its remaining shares in the joint venture to the supplier ( see below, Joint venture or partnership ). The supplier either runs the division separately or integrates it into its business group.
Joint venture or partnership. The parties can set up a joint
ven-ture or run an outsourced division in the form of a joint venven-ture. Parties typically choose to create a joint venture if material assets or confi dential information are to be transferred. The advantages and disadvantages are the same as for indirect outsourcing ( see above, Direct and indirect outsourcing ).
Captive entity. In this structure, certain divisions within a
com-pany are internally outsourced to establish specifi c centres of competence or shared service centres. The internally-outsourced centres can enter into consultancy agreements with outsourcing companies. The advantages of using the captive entity structure are:
The pooling of know-how within the company. The reduction of redundancies.
The disadvantages of using this model are that: Any cost reduction may be limited.
Specialist know-how from outsourcing providers cannot be used.
Asset or share deal. The assets in an outsourcing can be
trans-ferred through an asset or share deal:
Asset deal. In an asset deal, typically tangible items are
physically handed over under section 929 of the BGB and intangible items are transferred through assignment under section 398 of the BGB. Each individual asset must be clearly specifi ed to transfer it validly.
Share deal. The customer assigns the shares in the
out-sourced company to the supplier. The individual assets are automatically transferred to the new owner without the requirement to list each item.
See also Question 5 .
Supplier models
See above, Common structures. In addition, a number of suppli-ers can, either through a contract or through a partnsuppli-ership or joint venture, supply services to the customer. The partnership or joint venture between the suppliers must clearly defi ne the respective responsibilities and liabilities.
PROCUREMENT
4. Please briefl y describe the procurement process that is
usu-ally used to select a supplier of outsourced services (includ-ing due diligence and negotiation).
General
The process of selecting a supplier usually begins with establish-ing an interdisciplinary in-house project team from the relevant business areas affected by the outsourcing project.
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The customer may then decide to either:
Start a tender process for its outsourcing services. Approach one or more potential suppliers directly. The most appropriate procurement procedure depends on:
The services to be outsourced. The sophistication of the marketplace. The business objectives of the customer.
The outsourcing structure that the customer chooses ( see Question 3 ).
The tender process may give the customer more favourable terms and conditions because of the competition between the potential suppliers. It may also give the customer a broader choice of pos-sible services. However, it can be very time-consuming because of multi-party negotiations. For that reason, the customer usually restricts the tender process to three or four bidders.
Due diligence
As part of an internal due diligence, the customer must clearly defi ne:
The outsourcing’s requirements. Its scope.
Its services and service levels. The fi nancial standing of the supplier.
In addition, the customer should carry out economic and tech-nical due diligence of the supplier to ensure expected quality standards are met.
The supplier should carry out due diligence of all assets, con-tracts, facilities, rights, business divisions and so on that it will acquire. Based on the outcome of the due diligence, the supplier will further examine whether it can provide the services at a price that the customer is willing to pay, and whether the outsourcing would give the supplier a margin for its business, including any economies of scale.
Confi dentiality agreement
Usually the parties enter into a non-disclosure agreement before negotiations. Special consideration must be given to non-disclo-sure provisions in contracts with third parties.
Request for interest (RFI)
An RFI briefl y outlines the outsourcing project and invites the suppliers to provide an indicative offer, including documentation of the supplier’s abilities and fi nancial viability. The customer then prepares a shortlist of suppliers, based on their:
Abilities.
Cultural fi t (that is, the suitability of, for example, their
management style, team and customer orientation, political style, and attitudes).
Price.
Experience of the supplier in relation to the services in question.
Request for proposal (RFP)
An RFP describes the project, its scope, the services and service levels that the customer expects to be provided. It should ask specifi cally how the bidder can fulfi l these requirements. In ad-dition, it can ask for references in relation to the bidder’s experi-ence in outsourcing, as well as an invitation to provide an offer. When the responses are received, the customer must evaluate them against its own evaluation criteria.
Negotiations
Negotiations can be conducted with one or more bidders. At a more advanced stage, the bidder can ask for a certain period of exclusive negotiation to avoid lengthy negotiations that may not result in agreement.
TRANSFERRING OR LEASING ASSETS
5. What formalities are required to transfer the following assets on an outsourcing:
Immovable property?
IP rights and licences?
Movable property?
Key contracts?
Immovable property
Any agreement transferring immovable property requires notari-sation. If another agreement, such as an outsourcing contract or a lease agreement, is linked to the property purchase agreement so that the contracts are interdependent, the other agreement must also be notarised to ensure the validity of both agreements. For the transfer of immovable property, both of the following are required:
An agreement on the transfer of the right in rem to the acquirer ( conveyance of property, section 925, BGB ). Entering the change of the property’s legal position in the land register.
To minimise the potential risks of delays in the registration proc-ess, a priority notice should be entered into the land register. The parties may have to obtain authorisations required by public law such as the municipal pre-emption right under section 24 of the
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Building Law Act ( Baugesetzbuch (BauGB) ).If immovable property is to be transferred back to the customer (insourced) after termination of the outsourcing agreement, the agreement should include a pre-emption right or priority notice of conveyance, and the relevant entry into the land register should be made.
IP rights and licences
A copyright owner cannot transfer authorship to another party, but only certain rights attached to this authorship.
The parties must describe the IP rights in detail in order to trans-fer them. The transtrans-fer of certain IP rights should be followed by recording the change of ownership in the relevant registry, as only the registered owner of IP rights can bring proceedings before the Patent and Trademark Offi ce ( Deutsches Patent- und Markenamt ) and the courts.
Licences are not registered in Germany and no formal fi lings with the registration offi ces are necessary on transfer. The outsourc-ing contract should specifi cally describe the licence and the par-ties should ensure that the customer is entitled under its licence agreement to transfer the right to the supplier.
Movable property
The owner must physically transfer possession of the property and the parties must agree to transfer it.
Agreements relating to the transfer of movable property do not have to comply with any formalities. However, for reasons of clar-ity and evidence, they should be concluded in written form. An agreement regarding the transfer of movable property must only be notarised if all or part of the current assets of the cus-tomer are transferred to the supplier.
Key contracts
The types of key contract between the outsourcing customer and third parties can vary depending on the business of the customer and the type of outsourcing. They can include supply agreements, maintenance or other service agreements, lease agreements, li-cence agreements and so on.
The BGB only regulates the transfer of single claims and liabili-ties, but not the transfer of an entire contract. However, contracts can be transferred with the consent of all three parties (customer, supplier and the third party). This can be concluded as a tripar-tite agreement or as a two-party contract between the customer and the supplier with the consent of the third party (which can be given in advance).
The contract for the transfer of the key contract must follow the same formalities as the key contract itself, either imposed by legal provisions or by the agreement itself.
6. What formalities are required to lease or license the following assets on an outsourcing:
Immovable property?
IP rights and licences?
Movable property?
Key contracts?
Immovable property
Lease agreements must be concluded in written form if the lease term exceeds one year. Agreements relating to the leasehold of land must be concluded in written form if the lease term exceeds two years.
If the customer is the tenant of the property, it can also sub-lease the property to the supplier with the consent of the landlord, which may be given either in advance or on request and can gen-erally only be withheld for good reasons.
IP rights and licences
See Question 5, IP rights and licences .
Movable property
Lease agreements relating to movable property do not have to comply with any formalities, but for reasons of clarity and evi-dence, they should be concluded in written form.
Key contracts
Except for IP rights and licences ( see Question 5, IP rights and licences ), contracts cannot be leased or licensed.
TRANSFERRING EMPLOYEES
7. In what circumstances (if any) are employees transferred by operation of law:
To an incoming supplier on an initial outsourcing?
To an incoming supplier on a change of service provider?
Back to the customer on termination of an outsourcing?
Initial outsourcing
Protective legislation for employees plays a major role in out-sourcing transactions. Section 613a of the BGB is the key le-gal provision and it is largely based on Directive 2001/23/EC on safeguarding employees’ rights on transfers of undertakings, businesses or parts of a business. Where a business or parts of a business is transferred to a third party by contract, the employ-ees’ contracts with the transferor transfer to the transferee by operation of law.
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The decisive question is whether the business to be transferred is a long-term economic unit, which, despite the transfer, retains its identity. The courts consider all facts to determine whether this is the case. This assessment is usually based on the follow-ing criteria:
The type of business or company involved. The transfer of tangible and intangible assets.
The transfer of personnel or part of the personnel (key em-ployees) by the customer.
The transfer of the clients.
Any similarity of activities before and after the transfer. The duration of any interruption of activity.
If these criteria are met, the transferee takes on the rights and duties arising from the existing employment relationship. The transferee must fulfi l all obligations arising from the transferred employment relationship as if it were the original employer. Ter-mination of employment contracts for a transfer alone is prohib-ited. Managing directors or members of the management board are not transferred, as they are not considered employees under section 613a of the BGB.
Change of service provider
Section 613a of the BGB applies if the above criteria are met ( see above, Initial outsourcing ). To avoid the transfer of employ-ees, the new supplier must carefully review the former activities and, ideally, not use any assets or employees of the former sup-plier.
Termination
Section 613a of the BGB also applies if the services are in-sourced again.
8. Please describe the terms on which employees would transfer by law, including any effect on pensions, employee benefi ts or collective agreements that the transfer may have.
The legal consequence of a transfer of undertakings is that the employment relationships are transferred to the transferee as a whole.
Pensions
All pension liabilities of active employees are transferred. Pen-sion liabilities of penPen-sioners or former personnel of the trans-ferred business are not transtrans-ferred as they are not active, and their contracts are not transferred to the transferee.
Employee benefi ts
All contractual benefi ts of the employee are transferred. This also applies to share option plans with a German employer. If the rights are derived from share option plans with a parent company, they are not transferred.
Collective agreements
In transfer of undertakings, collective bargaining agreements (CBAs) and shop agreements either:
Remain collectively applicable if the transferee is a member of the same employer’s association as the transferor. Are transformed into individual contractual provisions for each employee and have the same legal character as provi-sions in an employment agreement.
If a CBA or a shop agreement with similar provisions is already in force with the transferee, it can replace the CBA or shop agree-ment that had been in force until the transfer ( see Question 11 ).
9. What information must the customer or the supplier provide to the other party in relation to any employees?
The customer and the supplier have no legal obligation to provide information to each other in relation to employees. Therefore, it is advisable to acquire this information in the due diligence process and implement appropriate clauses in the underlying contracts.
10. What information and consultation obligations arise for the customer and the supplier in relation to employees or em-ployees’ representatives?
The transferor or the transferee must inform each employee in writing before the transfer of the undertakings of:
The date or planned date of the transfer. The grounds for the transfer of the employees.
The legal, economic and social consequences of the trans-fer for the employees.
The intended measures to be taken in relation to the em-ployees.
The employees can object to a transfer of their employment rela-tionships within one month after they have been fully informed. If the employees object, the employment relationship remains with the transferor. If the information provided is incomplete, the employees have an unlimited right to object to the transfer. If, as a result of the outsourcing, the business is split up, sub-stantially reduced or its internal organisation is changed, this can be regarded as an operational change under section 111 of the Works Construction Act ( Betriebsverfassungsgesetz ). The works council must be informed and consulted before any such out-sourcing measure.
The purpose of the information requirements is to start discus-sions and negotiations between management and works councils, resulting in a written plan on the details of the proposed
out-
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sourcing measures (a reconciliation of interests (Interessensaus-gleich )). The reconciliation of interests describes: The operational changes to be made. The schedule.
How employees will be affected.
In addition, the works council can request a social plan ( Sozial-plan ) if a substantial number of employees will be affected. A social plan is an agreement between the management and the works council under which employees affected by operational changes are granted benefi ts to provide full or partial compensa-tion for any fi nancial detriments, particularly those resulting from unemployment.
The most commonly-disputed issue is redundancy payments. Redundancy payments are usually between one-half and one month’s salary per year of employment.
11. To what extent can a supplier harmonise terms and condi-tions of transferring employees with those of its existing workforce?
The transferee cannot modify the terms of the employment rela-tionship to the employee’s detriment before one year has passed. It is possible to apply existing CBAs to the transferred employees if the employees fall within the scope of the CBAs or are con-tractually bound by the agreements by their former employer’s agreements through general applicability clauses.
12. To what extent can dismissals be implemented before or after the outsourcing?
A dismissal is invalid if it is due to the transfer of a business or part of a business, that is, if the transfer is the motive for the dis-missal ( section 613a (4), BGB ). Dismissals on other grounds (for example, relating to the employee’s conduct or for operational reasons) are permissible.
If an employee objects to the transfer of his employment relation-ship to the transferee, and the transferor cannot retain him, then the employee can be dismissed for operational reasons.
13. In what circumstances (if any) is it possible for the parties to structure the employee arrangements of an outsourcing as a secondment?
The mandatory provisions of section 613a of the BGB apply even if other contractual arrangements, such as a secondment, have been made.
DATA PROTECTION
14. What data protection issues may potentially arise on an out-sourcing and how are they typically dealt with in the contract documentation?
In general, only personal data is subject to enhanced protection under the law. Personal data is defi ned as individual information on the personal or factual relations of an identifi ed or identifi able natural person.
Any use of personal data, including the collection, storage and transfer of data, is regulated by the BDSG. Area-specifi c legisla-tion may apply to data transfers in telecommunicalegisla-tions, teleserv-ices and media servteleserv-ices, or banking and fi nance ( see Question 2 ).
Generally, a storage unit must:
Provide for access control, data entry control and protection from loss of data.
Oblige its employees to obey data secrecy. Appoint a data protection offi cer.
Report any use of data through data processing equipment. If a data transfer takes place within the European Economic Area (EEA), it requires either statutory permission or permission by the person concerned. Data can only be transferred outside the EEA if the data subject has no interest in being protected. A person is usually found to have such an interest if the standard of data protection in the transferee country is lower than the EU standard. In this case, the permission of the person concerned must be obtained.
During an outsourcing project, a data transfer can occur in two different ways, either:
As data processing on assignment ( Auftragsdatenverar-beitung ) (that is, the outsourcing company intentionally outsources data processing). In that case, the supplier is strictly bound by the customer’s instructions and is not itself responsible under most of the regulations. The cus-tomer remains liable for most of the obligations under the BDSG.
As a by-product of the outsourcing of a function. In this case, both the customer and the supplier must comply with the regulations because the supplier is considered to be a third party. Therefore, transfer to and from the supplier is a relevant data transfer, which is subject to the regulations. The parties usually describe the data that is transferred, includ-ing the reason for the transfer and how it is to be handled. The agreement states the obligations of each party to ensure that they comply with all relevant regulations.
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SERVICES
15. How is the services specifi cation typically drawn up and by whom?
Both parties usually contribute to the services specifi cation. It is a crucial element of the outsourcing transaction and must be carefully drawn up. The customer is generally better equipped to decide what services it needs to receive and how those services can be adapted during the term of the outsourcing contract. It must ensure that it receives the services at a certain level of qual-ity and on an agreed cost basis. The supplier must specify what service levels it can provide based on its previous experience. The services specifi cation is the benchmark for its calculation relating to the services to be provided and the fees.
Therefore, the outsourcing agreement typically provides for: A detailed description of the services in question. A clear division of the responsibilities of the parties in rela-tion to those services.
16. How are the service levels and the service credits scheme typically dealt with in the contract documentation?
Service levels set out the specifi c performance and services which the supplier must provide to the customer. In the absence of any agreed service levels, the supplier must provide services of an average quality ( section 243, BGB ). However, this is usually not suffi cient for the purposes of an outsourcing.
The service levels are generally included either as part of the main outsourcing agreement or in annexes to the agreement. Service levels also divide responsibilities between the parties and are the basis for key performance indicators, contractual penal-ties, damage claims and termination rights ( see Question 21 ). They often include:
Escalation procedures. Re-negotiation provisions. Reaction times.
Availability.
Standard change requests.
A set procedure for non-performance.
Service levels must be drafted clearly as the parties can only judge the fi nancial impact of the outsourcing transaction if they know what services will be provided. At the same time, service levels should be fl exible, to deal with changes over time and be able to be modifi ed by customer demands.
Service level credits give the customer the right to lower the fees where the supplier does not perform as agreed in the service
levels. Usually certain percentages are deducted from the fees owed, depending on the level of non-performance. Where service level agreements are considered to be standard terms and condi-tions ( section 305, BGB ), the value of the deduction cannot be higher than the typical expected damages of the customer.
CHARGING
17. Please describe the charging methods that are commonly used on an outsourcing (for example, risk or reward, fi xed price, cost or cost plus, pay as you go, resourced-based charges, use of minimum charges and so on).
Fixed- and fl exible-price models
Fixed-price models are suitable if the supplier must build a spe-cifi c product or if the scope and volume of the service can be pre-determined and the customer wants certainty for budgeting purposes.
Flexible prices are usually based on the actual accrued time or other units.
Combination of fi xed- and fl exible-price bases
Fixed- and fl exible-price bases are regularly combined depending on the nature of the service. A fi xed price may typically be chosen to produce the service and additional services may be charged on a fl exible basis.
Cost plus
Cost plus is the payment of the actual costs incurred, plus an additionally-agreed profi t margin for the supplier. It is necessary for the parties to include mechanisms for cost determination and review, such as benchmarking and automatic adjustments.
Risk or reward
A risk or reward provision regulates the results of the delivered performance level (that is, if less than the agreed performance level is reached, the supplier is paid less; if performance exceeds the agreed specifi cations, a bonus is paid).
18. Please briefl y describe any other key terms used in relation to costs, such as charge variation mechanisms and indexation.
Implementation costs
The parties must decide whether the supplier can recover its implementation costs at the beginning or whether the costs are spread over the life of the outsourcing agreement. In the former case, payment is generally subject to certain conditions. It is ad-visable for the parties to agree on a partial initial payment with further payments depending on clearly-defi ned and determinable progress. If the implementation costs are spread over the life of the agreement, the parties should include a clear provision stat-ing which party bears the remainstat-ing unpaid implementation costs if a party terminates the agreement.
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Adjustment and benchmarking provisions
Adjustment provisions must comply with section 2 of the Price Quotation and Price Clause Act ( Preisangaben- und Preisk-lauselgesetz ) and the underlying Price Clause Regulation ( Preisk-lauselverordnung ). Under these rules, certain automatic adjust-ment clauses are subject to the approval of the Federal Offi ce of Economics and Export Control ( Bundesamt für Wirtschafts- und Ausfuhrkontrolle (BAFA) ).
For benchmarking, see Question 20, Benchmarking .
CUSTOMER ISSUES
19. If the supplier fails to perform its obligations, what relief is available to the customer under general law?
Implied warranties apply for faulty or non-performance of essen-tial obligations. A claimant has the right to:
Demand performance and/or damages. Demand supplementary performance. Rescind the contract.
Because of the contract’s nature as a continuing obligation and the expectations of trust from both parties, the right to rescind is usually replaced by a right to extraordinarily terminate the con-tract, if a reason for termination exists .
Where there is termination for non-performance of one element of the outsourcing agreement, the validity of the rest of the contract depends on whether the various obligations were meant to be in-terdependent, as construed in accordance with the parties’ inten-tions. The exact nature and requirements of these rights depend on the classifi cation of the individual contract provision.
20. What customer protections are typically included in the con-tract documentation to supplement relief available under general law?
Governance
Governance is the name for the project structure used to deal with open issues or disagreements within the outsourcing. In addition to the operative level, controlled by the project management, the parties usually implement a “steering board” to deal with issues unresolved by the project management.
Change management
Change request clauses (that is, provisions enabling a party to request changes to services or service levels from the other party) give the customer fl exibility in relation to the future services re-quirements. They can also enable improvements or innovations in services, which originate from the marketplace or the supplier, to be implemented into the original contract structure.
Any change request clause must defi ne whether a signifi cant change or merely a slight adaptation (for example, of volumes or service times) is requested. Slight adaptations can be provided for by specifi c fl exible clauses, such as:
Rolling forecasts (that is, predictive budgeting methods to improve accountability).
Staggered pricing systems (that is, different prices per unit, depending on the amount of units provided).
Changes must often be made to the specifi cation of services or to pricing arrangements. It may be appropriate to agree on a neutral third person to examine whether the requested change is techni-cally possible, as well as the remuneration for it.
Benchmarking
Although the supplier originally offers services and prices in line with the market, this may change during the term of the agree-ment. To ensure that they continue to be in line with the market, the parties can agree to conduct benchmarking processes, either during the term or at the end of it, to decide whether to renew services.
Benchmarking is carried out either:
By asking an expert to provide a professional opinion on the issues.
Through a market price comparison offered by competitors of the supplier.
Benchmarking requires an exact defi nition of not only the servic-es to be provided but also of any provisions on liability including potential caps, provisions concerning change management and so on. In addition, the contract usually defi nes the consequences of the benchmarking (for example, whether the customer can (im-mediately) terminate the agreement or whether the supplier is entitled to provide a last bid).
Monitoring, reporting and auditing
Generally, the supplier must monitor and keep books about its services and any failures in performance.
The parties can also agree on auditing rights for the customer to ensure that the reports are accurate. An independent third party, such as certifi ed accountants, typically conducts the audit. The parties must agree on:
The auditor.
The regularity of the audit. Costs.
The consequences of any deviations.
Country Q&A
Security
Appropriate methods of security can include:
A bank guarantee for performance claims or for warranty claims.
A letter of comfort from the fi nancially stable parent com-pany.
Appropriate insurance cover.
21. What protections for deteriorating service performance (be-fore triggering termination) are typically included in the con-tract documentation?
The parties should clearly express whether they wish to exclude the statutory regulations (to the extent possible) or supplement them.
Liquidated damages
A liquidated damages clause can be agreed, which means that the customer will not need to prove the amount of damages in the case of deteriorating service performance. This is subject to limitations. Damages exceeding the agreed liquidated damages cannot be claimed. In standard terms and conditions, the follow-ing are prohibited ( section 309, BGB ):
An agreed lump sum that exceeds the damages that may ordinarily be expected.
A clause where the supplier is not explicitly permitted to prove lower damages.
Contractual penalty
A contractual penalty allows the customer to demand payment without proving that damages have been incurred at all. Damages exceeding the amount of the contractual penalty can also be de-manded but, in standard terms and conditions, they must be set off against the contractual penalty.
Increase of control
The parties can also agree to an increase of the various control functions, such as reporting and auditing. Unlike liquidated dam-ages or a contractual penalty, this usually serves to prevent fur-ther deterioration instead of penalising past faulty performance.
WARRANTIES AND INDEMNITIES
22. What warranties and/or indemnities are typically included in the contract documentation?
Warranties
Parties commonly negotiate specifi c warranties in addition to the warranties implied by law. The warranties should be drafted
to-
gether with the service levels, the service level credits and any penalties ( see Questions 15 , 16 and 21 ).
Typical warranties given to the customer include: The right to demand remedy of defects. The right to decrease the charges. The right to demand damages.
Certain warranties regarding the assets and goods in the event of insourcing.
A warranty that the services will be provided with reason-able skill and care.
Typical warranties given to the supplier include: Assignment of warranty claims against third parties. Warranties regarding legal ownership of rights to be trans-ferred.
Warranties in relation to the correctness and completeness of information relating to the transferred employees.
Indemnities
Generally, the parties include indemnifi cation against third par-ty claims. In addition, the customer can seek indemnifi cation against future liability regarding the insourcing of employees af-ter af-termination of the outsourcing agreement, and the supplier can request indemnifi cation against historic liability relating to outsourced employees.
23. What limitations are imposed by national law on fi tness for purpose and quality of service warranties?
In the absence of any contractual specifi cations concerning the quality of the service, statutory warranties only apply if the serv-ices provided do not reach at least an average level.
In relation to fi tness for purpose, German law differentiates be-tween works contracts and service contracts. If the service is pro-vided in the form of a works contract, the supplier must provide services to a certain level (that is, it owes a certain success). However, if it is a service contract, the supplier need only provide the service, without any warranty for the fi tness for its purpose. Unless the parties agree on the specifi c success of the service or its fi tness for a specifi c purpose, it is up to a court to decide whether certain services provided were intended as a works con-tract or as a service concon-tract.
In a purchase contract, a warranty as to the fi tness for purpose depends on whether any of the following apply:
The parties have explicitly agreed on a certain purpose.
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The item purchased fi ts the purpose contemplated underthe agreement, in the absence of an explicit agreement. The item fi ts the purpose that is usually expected by the buyer when buying such an item.
TERM AND NOTICE PERIOD
24. Does national law impose any maximum or minimum term on an outsourcing? If so, can the parties vary this by agree-ment?
The law does not impose a maximum or minimum term on out-sourcing agreements. Generally, contracts have a duration of fi ve to ten years.
25. Does national law regulate the length of notice period re-quired (maximum or minimum)? If so, can the parties vary this by agreement?
National law does not impose an explicit maximum or minimum notice period. Notice periods can be agreed on between the sup-plier and the customer.
For extraordinary termination with good cause under section 314 of the BGB ( see Question 26 ), no notice period must be complied with. The contract comes to an end at the moment the notice is served, provided either:
The customer has given the supplier a warning letter. The customer has given the supplier a chance to remedy the situation if the termination is for failure to perform a contractual duty.
However, in certain circumstances, the party serving notice may be required to grant to the other party a phasing-out period if nec-essary to protect the interests of the other party. This allows the contractual relationship to continue for a limited time to enable the parties to make all necessary arrangements for ending the contractual relationship. In addition, the terminating party must terminate the contract within an appropriate period of time after receiving knowledge of the reason for termination.
TERMINATION AND TERMINATION CONSEQUENCES
26. What events are considered under national law suffi cient to justify termination of an outsourcing rather than a claim in damages (for example, fundamental breach, repudiatory breach, insolvency events and so on)?Extraordinary termination requires a good cause to terminate the agreement. There is good cause if, when considering all circum-stances and taking into account the mutual interests of both par-ties, continuation of the agreement is unacceptable for the termi-nating party. Default of the other party is not required.
A termination right for insolvency is subject to section 119 of the Insolvency Act ( Insolvenzordnung ). Any agreement that ex-cludes or restricts the insolvency procedure or the freedom of the insolvency administrator to choose whether he wishes to fulfi l a contract or not is invalid.
27. In what circumstances can the parties exclude or agree ad-ditional termination rights (for example, for breach, change of control, convenience and so on)?
The parties can agree additional termination rights such as an option for ordinary termination (that is, the parties have a right to terminate the agreement with notice for any or no reason) even within the fi xed term. This agreement may contain provisions re-garding a compensation payment for early termination.
Grounds for extraordinary termination are commonly set out in the outsourcing agreement. These often include:
Non-payment of the service fee by the customer.
Serious non-performance of the service level agreements by the supplier.
Change of control.
The parties can also agree on an extraordinary or ordinary ter-mination for convenience, which usually includes compensation payments by the terminating party.
28. What implied rights are there for the supplier to continue to use licensed IP rights post-termination? To what extent can these be excluded or included by contract?
The continued use of licensed IP rights post-termination depends on the specifi c terms of the licence. The customer usually does not grant a licence post-termination unless there are certain ben-efi ts to doing so. In the absence of any specifi c provisions, it is generally implied that the licence terminates when the outsourc-ing agreement terminates.
29. To what extent can the customer gain access to the supplier’s know-how post-termination and what use can it make of it?
The customer cannot gain access to the supplier’s know-how after termination of the outsourcing agreement, unless good faith de-mands this or it is explicitly stated in the agreement. Good faith may be given if the customer cannot continue its business at all without the supplier’s know-how. Therefore, the parties should provide for any desired transfer of know-how after termination in detail in the outsourcing agreement. The customer can make use of the know-how of insourced employees unless it is protected by confi dentiality agreements or is otherwise protected as a business secret of the supplier.
Country Q&A
LIABILITY
30. What liability can be excluded? In particular, is it possible for the supplier to exclude liability for indirect and consequen-tial loss and also any loss of business, profi t or revenue?
Liability can be contractually excluded unless it is mandatory un-der law. Mandatory liability includes intentional acts and claims based on product liability. Usually, the parties agree on certain caps for liability in cases where liability is not mandatory. If the parties have agreed on certain penalties relating to service levels, liability clauses should refl ect these penalties ( see Question 21, Contractual penalty ). If the terms of the outsourcing agreement are considered to be standard terms and conditions under section 305 of the BGB, liability for any intentional or negligent injury to life, health or body is mandatory. In addition, liability for gross negligence can only be restricted in limited cases.
In the absence of any contractual limitations on liability, dam-ages include all loss, including indirect, consequential damdam-ages, and loss of profi ts.
31. Are the parties free to agree a cap on liability?
The parties are free to agree a cap on liability unless liability is mandatory under German law ( see Question 30 ).
TAX
32. What are the main tax issues that arise on an outsourcing in relation to:
Transfers of assets to the supplier?
Transfers of employees to the supplier?
Value added tax (VAT) or the equivalent sales tax on the service being supplied?
Other signifi cant tax issues?
Transfer of assets to the supplier
This depends on whether the outsourcing is structured as an as-set or share deal ( see Question 3, Common structures: Asset or share deal ).
Asset deal. In an asset deal, the sale of the assets affects the
customer’s income tax liability. One of the main tax issues that may arise is revealing hidden reserves through the sale of assets. Depending on the outsourcing transaction, the customer can structure the transfer so as to prevent revealing hidden reserves or to transfer hidden reserves on a tax-free basis.
The transfer of assets can otherwise be tax-free if certain condi-tions are met under the Reorganization Tax Act ( Umwandlungss-teuergesetz (UmwStG) ).
Stamp duty at a rate of up to 3.5% can arise on transfers of real property.
Share deal. In a share deal, tax implications depend on the legal
form of the customer. If the customer is a corporation, the transfer of shares is regulated by section 8(b) of the Corporation Tax Law ( Körperschaftsteuergesetz (KStG) ). Under certain circumstances, the capital gain is exempt from corporate income tax in addition to excise tax. If the customer is a partnership, the transfer of shares is regulated by section 3, No. 40a of the Income Tax Law ( Einkommensteuergesetz (EstG) ).
Transfers of employees to the supplier
If the supplier becomes the new employer of the transferred em-ployees ( see Question 7 ), all employer’s responsibilities apply to it. It must withhold income tax and social security contributions from the employee’s salary and transfer them to the respective authorities.
VAT or sales tax
For the customer, payment for services or goods being supplied is subject to the applicable rate of VAT (currently 19%).
Generally, certain services provided by banks and fi nancial insti-tutions are exempt from VAT ( section 4, No. 8, VAT Code (Um-satzsteuergesetz (UstG) ). If a fi nancial institution outsources such fi nancial services to the supplier, there is a risk that the services provided by the supplier do not fall within the tax ex-emption and VAT obligations arise. This has become a signifi cant issue in the fi nancial services sector and should be carefully ex-amined in each particular case.
Other
