Country Q&A
Germany
Stephan Rippert and Katharina Weimer, Reed Smith LLP
www.practicallaw.com/7-384-9497
GenerAl
1. To what extent does national law specifically regulate out-sourcing transactions?
National law does not specifically regulate outsourcing transac-tions. This presents challenges in drafting and concluding an agreement that satisfies both parties’ requirements. An outsourc-ing agreement is a mixed-type agreement, which can include vari-ous different contract types regulated by the German Civil Code (Bürgerliches Gesetzbuch (BGB)), for example:
Sales contracts.
Lease contracts (see Question 6). Works contracts (see Question 22).
Contracts regulating the transfer of assets or shares (see Question 3, Asset or share deal).
The BGB’s provisions apply to outsourcing agreements to the ex-tent that they contain aspects of these contract types.
2. What additional regulations may be relevant on: A financial services outsourcing?
A business process outsourcing? An IT outsourcing?
A telecommunications outsourcing? A public sector outsourcing? Other outsourcings?
Financial services
The outsourcing of financial 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 financial system. The applicable law depends on the nature of the financial 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 ( Bundesdatenschutzge-setz (BDSG)).
Respective state statutes.
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
financial services institutions include, among other things, invest-ment and contract brokers, and portfolio managers. The outsourc-ing of operational areas that are essential for conductoutsourc-ing bankoutsourc-ing business or providing financial services to third parties is:
Subject to regulatory law.
Supervised by the German Federal Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)). The outsourcing must not impair the (section 25a, Banking Act (Kreditwesengesetz (KWG))):
Customer’s proper organisation of business and services. Customer’s ability to properly and effectively manage risks, including the outsourced services.
BaFin’s right to audit and ability to monitor the business or services.
BaFin issued Circular No. 5/2007 on 30 October 2007 for Mini-mum Requirements for Risk Management ( Mindestanforderun-gen an das Risikomanagement) (revised Circular). This includes requirements for banks and financial services institutions that outsource, and supersedes Circular No. 11/2001. The revised Circular ensures compliance with:
The guidelines on Outsourcing issued by the Committee of European Banking Supervisors.
Directive 2004/39/EC on markets in financial instruments, which became effective on 1 November 2007.
The revised Circular provides detailed guidance on the outsourc-ing requirements. In particular:
Core management functions (Leitungsaufgaben der Ge-schäftsleitung) cannot be outsourced. This includes activi-ties that are legally assigned to management (for example, strategy formation), and the selection of executive officers.
Country Q&A
The customer remains responsible for compliance with all regulatory requirements, and cannot delegate these to the supplier.
The customer must include any outsourced activities in its risk management process, and provide for proper supervi-sion. If the internal auditing is outsourced, the customer must appoint an auditing officer.
Contracts for the outsourcing of essential areas (which the customer self-assesses on the basis of a risk analysis) must include:
the definition of the operational area to be outsourced; the specification of the customer’s information and auditing rights;
safeguarding the BaFin’s information, control and auditing rights;
the customer’s right to give instructions;
compliance with data protection requirements (see Question 14);
proper termination rights;
a clause insisting that any subcontracting will follow all the Circular’s requirements for outsourcing; the supplier’s information obligations.
Outsourcing by investment services companies. Investment
serv-ices companies (Wertpapierhandelsunternehmen), such as brokers and investment traders, are subject to section 33(2) of the Secu-rities Trading Act (Wertpapierhandelsgesetz) (WpHG). Its require-ments are identical to those of section 25a of the KWG (see above, Outsourcing by credit and financial services institutions).
Outsourcing by investment companies. Capital investment
com-panies (Kapitalanlagegesellschaften) can outsource their busi-ness activities if the outsourcing does not hinder the company from acting in the investors’ interests.
This outsourcing is subject to:
Section 16 of the Investment Act (Investmentgesetz(InvG)). Section 25a of the KWG.
The capital company’s rules on the distribution of invest-ments (which are set on a regular basis).
The capital investment company:
Remains liable for any of the supplier’s faults.
Must list the outsourced tasks in the sales prospectus, which it must publish in accordance with section 42 of the InvG. If the transfer concerns portfolio management, only companies licensed for asset management and subject to effective public supervision can carry out the business.
It is currently unclear whether and to what extent the revised Cir-cular applies to capital investment companies, as it in principle only applies to financial institutions (that is, banks and financial services companies). The regulatory authorities are likely to rule on this issue when it arises.
Business process
Outsourcings in areas such as human resources and facility sup-port are subject to:
The BGB’s general provisions. Employment laws.
Data protection laws. Other relevant statutes.
IT
There are no additional regulations that are relevant to an IT out-sourcing.
Telecommunications
The supplier must observe the secrecy of telecommunications rules set out in section 88(2) of the Telecommunications Act (Telekommunikationsgesetz (TKG)). In addition, specific 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 financial thresholds, it must be carried out through an official tender process regulated by the Act against Restraint of Competition (Gesetz gegen Wettbewerbsbeschränkung (GWB)). In addition, the following may need to be observed:
The Tender Procedure (Vergabeordnung).
The Contracting Rules for Awards of Public Service ( Verdin-gungsordnung für freiberufliche Leistungen (VOF)), of Pub-lic Works (Vergabe und Vertragsordnung für Bauleistungen (VOB)) and of Delivery (Verdingungsordnung für Leistungen (VOL)).
Public procurement above certain financial 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.
Country Q&A
Other
There are no other relevant additional regulations.
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.
Outsourcing deals can be structured in various ways between the parties.
Direct outsourcing
Outsourcing deals are usually structured as a direct outsourcing or indirect outsourcing. A direct outsourcing involves a contract between the customer and the supplier.
The advantages of a direct outsourcing include that:
Additional joint venture (JV) or partnership agreements are not necessary.
In case of termination, there is no need to dissolve entities or partnerships.
There are clear objectives (that is, for the customer to gain service quality, and for the supplier to make a profit). The disadvantages of a direct outsourcing include:
Loss of know-how. Loss of control.
No vehicle to provide services for third parties.
Indirect outsourcing
In an indirect outsourcing, there is no direct outsourcing contract between the customer and supplier.
The advantages of an indirect outsourcing include the: Opportunity for both parties to make use of their respective know-how.
Opportunity to gradually transfer the service into a JV or other vehicle.
Use of a vehicle to provide services to third parties. 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. In addition, in an exit scenario, the JV must be dissolved in addition to terminating the outsourcing agreement.
In international outsourcings, the parent companies typically enter into a framework agreement, and the subsidiaries in the
respective countries provide the international services. The sub-sidiaries can also become parties to the outsourcing agreement or enter into separate contracts under the framework outsourcing agreement. In these cases, certain guarantees by the parent com-pany should be considered.
An indirect outsourcing could be, for example, a JV between the customer and the supplier, together with an outsourcing agree-ment between the customer and the JV (see below, JV or partner-ship).
JV or partnership
The customer and supplier set up a JV for the outsourcing, or run an outsourced division in the form of a JV. Suppliers can also form a JV or partnership between them. Parties typically choose to create a JV if material assets or confidential information are to be transferred. The advantages and disadvantages are the same as for indirect outsourcing (see above, Indirect outsourcing). Re-sponsibilities and liabilities must be clearly defined.
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 outsources the division to the sup-plier. It can be transferred to the supplier through either:
An asset or share deal (see below, Asset or share deal). A JV between the customer and the supplier. Generally, after a period of three to seven years, the customer transfers its remaining shares in the JV to the supplier (see above, JV or partnership).
The supplier either runs the division separately or integrates it into its business group.
Captive entity
Certain divisions within a company are internally outsourced to establish specific centres of competence or shared service cen-tres. The internally outsourced centres can enter into consultancy agreements with outsourcing companies. The advantages of us-ing the captive entity structure are the:
Pooling of know-how within the company. 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 transferred 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
Country Q&A
section 398 of the BGB. Each individual asset must be clearly specified to transfer validly.
share deal. The customer assigns the shares in the
out-sourced company to the supplier. The individual assets automatically transfer to the new owner without the require-ment to list each item.
For tax liabilities on asset deal or share deal, see Question 31, Transfers of assets to the supplier.
See also Question 5.
PrOCuremenT
4. Please briefly 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.
The customer may then decide to either:
Start a tender process (with or without a request for pro-posal (RFP)) for its outsourcing services.
Approach one or more potential suppliers directly. The most appropriate procurement procedure depends on the:
Services to be outsourced. Sophistication of the marketplace. Business objectives of the customer.
Outsourcing structure that the customer chooses (see Ques-tion 3).
The tender process may give the customer more favourable terms and conditions because of 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. Therefore, the customer usually re-stricts the tender process to three or four bidders.
Due diligence
As part of an internal due diligence, the customer must clearly define the:
Outsourcing’s requirements. Outsourcing’s scope.
Outsourcing’s services and service levels.
Supplier’s financial standing.
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.
The outsourcing would give the supplier a margin for its business, including any economies of scale.
Confidentiality 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 briefly outlines the outsourcing project and invites the suppliers to provide an indicative offer, including documentation of the supplier’s abilities and financial viability. The customer then prepares a shortlist of suppliers, based on their:
Abilities.
Cultural fit (that is, the suitability of, for example, their management style, team and customer orientation, political style, and attitudes).
Price.
Experience in relation to the services in question.
rFP
An RFP describes the project, its scope, the services and service levels that the customer expects to be provided. It should ask specifically how the bidder can fulfil 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 customer receives the responses, it 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 an exclusive nego-tiation period to avoid lengthy negonego-tiations that may not result in agreement.
Country Q&A
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 to transfer immovable property requires notarisa-tion. 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 (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 Building Law Act (Baugesetzbuch (BauGB)).
If immovable property is to be transferred back to the customer (in-sourced) after termination of the outsourcing agreement, the agree-ment should include a pre-emption right or priority notice of convey-ance, 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 can transfer certain rights attached to this authorship. The parties must describe the IP rights in detail to transfer them. The transfer 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 Trade-mark Office (Deutsches Patent- und Markenamt) and the courts. Licences are not registered in Germany and no formal filings with the registration offices are necessary on transfer. The outsourc-ing contract should specifically describe the licence and the par-ties should ensure that the customer is entitled under its licence agreement to transfer or sublicense 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 that relate 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 be notarised if all or part of the customer’s current assets are transferred to the supplier.
Key contracts
The BGB only regulates the transfer of single claims and liabili-ties, and not the transfer of an entire contract. However, con-tracts can be transferred with the consent of all three parties (customer, supplier and the third party). This can be obtained through either a:
Tripartite agreement.
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.
If the customer is the tenant of the property, it can also sublease 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
There are no formality requirements for lease agreements that re-late to movable property, but for reasons of clarity and evidence, they should be concluded in written form.
Key contracts
Contracts cannot be leased or licensed.
Country Q&A
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 supplier? 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 provides the key legal protection for transferred employees, 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 the whole or part of a business is transferred to a third party by contract, the employees’ contracts with the transferor transfer to the transferee by operation of law. Managing directors or members of the man-agement board are not transferred, as they are not considered employees under section 613a.
The business is transferred if it is a long-term economic unit, which, despite the transfer, retains its identity. The courts con-sider all facts to determine whether this is the case. The assess-ment is usually based on the following criteria:
The type of business or company involved.
Whether tangible and intangible assets are transferred. Whether key employees are transferred.
Whether clients are transferred.
Any similarity of activities before and after the transfer. The duration of any interruption of activity.
According to the latest Federal Labour Court judgments, in nu-merous outsourcing transactions the determining factor is wheth-er the incoming suppliwheth-er takes ovwheth-er any tangible assets.
Change of supplier
If a change of supplier constitutes a business transfer (see above, Initial outsourcing), the new supplier takes on all the employment relationships that existed with the old supplier as part of this business. To avoid the transfer of employees, the new supplier must carefully review the old supplier’s activities and, ideally, not use any of the old supplier’s assets or employees.
Termination
If services are insourced again, and this constitutes a business transfer (see above, Initial outsourcing), the customer takes on all the employment relationships that existed with the supplier as part of this business.
8. Please describe the terms on which employees would trans-fer by law, including any effect on pensions, employee ben-efits or other matters (including collective agreements) that the transfer may have.
General terms
On a business transfer, the transferee succeeds to the rights and duties arising from the employment relationships as if it were the transferor.
Pensions
On a business transfer, the transferee takes on all pensions rights of active employees of the business. Pensioners and former per-sonnel of the transferred business do not have their contracts and pensions rights passed on to the transferee, as they are not active employees.
employee benefits
On a business transfer, the transferee takes on all contractual ben-efits of the employees of the business, even if they are not explic-itly stated in the employment agreement. This also applies to share option plans offered by a German employer, unless the rights are derived from share option plans with a parent company.
Other matters
On a business transfer, collective bargaining agreements (CBAs) and shop agreements that were in force between the employees of the business and the transferor either:
Remain in force on a collective basis provided that: in relation to CBAs, the transferee is a member of the same employer’s association as the transferor; or in relation to shop agreements, the transferred busi-ness operation retains its identity.
Are transformed into individual contractual provisions for each employee and have the same legal character as provi-sions in an employment agreement.
The employer cannot modify the transferred employees’ CBA or shop agreement to their detriment until one year after the transfer. If the transferee already has a CBA or a shop agreement with sim-ilar provisions in force with its own employees, it can replace the transferred employees’ CBA or shop agreement with its existing one (see Question 11). It can only do so if the transferred employ-ees fall within the scope of its existing CBA or shop agreement, or are bound to them through general applicability clauses.
9. What information must the transferor or the transferee pro-vide to the other party in relation to any employees?
The transferor and transferee have no legal obligation to provide information to each other in relation to employees. Therefore, it
Country Q&A
is advisable for the parties to acquire this information during thedue diligence process and to implement appropriate clauses in the underlying contracts.
10. What information and consultation obligations arise for the transferor and the transferee in relation to employees or em-ployees’ representatives?
Before a business transfer, the transferor or the transferee must inform each employee, in writing before the transfer, of the:
Date or planned date of the transfer. Grounds for the transfer of the employees.
Legal, economic and social consequences of the transfer for the employees.
Intended measures to be taken in relation to the employees. The employees can object to a transfer of their employment rela-tionships within one month after they have been fully informed. If the employer provides incomplete or false information, the em-ployees have an unlimited right to object to the transfer. If an employee objects, his employment relationship remains with the transferor, unless the transferor is unable to keep him on (see Question 12).
If a business is transferred as a whole, the works council has no co-determination rights. However, if a business is split up or sub-stantially reduced, or its internal organisation changed, this can be considered an operational change under section 111 of the Works Construction Act (Betriebsverfassungsgesetz (BetrVG)). This means that the transferee must inform and consult the rel-evant works council before the outsourcing.
The purpose of this information requirement is to start discus-sions and negotiations between management and the works coun-cil. The negotiations end in a written plan on the details of the proposed outsourcing measures (reconciliation of interests ( Inter-essensausgleich)). The reconciliation of interests describes:
The operational changes to be made. The schedule of changes.
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 by the changes. This is an agreement between the management and the works council which grants benefits to affected employees, to provide full or partial compensation for any financial detriment, particularly that resulting from unemployment.
The most commonly disputed issue is redundancy payments. Re-dundancy payments are usually between half and one month’s salary per year of employment.
11. To what extent can a transferee harmonise terms and con-ditions of transferring employees with those of its existing workforce?
The transferee can modify the terms of the transferred employ-ees’ employment agreements to the same extent as the transferor was able to. In particular, it can do this through:
An amendment agreement.
Dismissal with the option of altered employment conditions. On a business transfer, any modification of an employment agree-ment that is substantially to the employee’s detriagree-ment is subject to justification on objective grounds (see Question 8, General terms). For the modification of CBAs or shop agreements on a business transfer, see Question 8, Other matters.
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, under certain circumstances, 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?
If a transfer of a business falls under the scope of section 613a of the BGB, it applies even where 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 defined as individual information on the personal or factual relations of an identified or identifiable natural person.
The BDSG regulates any collection, processing and use of per-sonal data (data processing). Area-specific legislation may apply to personal data in the telecommunications and media, health, banking and finance sectors (see Question 2).
Country Q&A
Generally, a data collector must:
Provide for technical data security measures and protection from loss of data.
Oblige its employees to obey data secrecy rules. Appoint a data protection officer.
Data processing within the European Economic Area (EEA) requires either statutory permission or express consent by the data subject. 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 an interest in being protected if the recipient’s standard of data protection is lower than the EU standard. In this case, the consent of the person concerned must be obtained, unless a statu-tory exception applies. The EU standard can be achieved, for ex-ample, if the recipient of the data joins the safe harbour (for the US) or has entered into the EU model contract with the customer. During an outsourcing project, a data transfer can occur in two different ways, as either:
Data processing on assignment ( Auftragsdatenverarbei-tung) (that is, the customer outsources data processing). In this case, the supplier is strictly bound by the customer’s instructions and is not itself responsible under most of the regulations. The customer remains liable for most of the obligations under the BDSG.
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 rel-evant data transfer, which is subject to the regulations. The parties usually describe the transferred data, including the reason for 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.
serVICes
15. How is the services specification typically drawn up and by whom?
The services specification is a crucial element of the outsourcing transaction and must be carefully drawn up. Both parties usually con-tribute to it. The customer is generally better equipped to decide what services it needs to receive and how those services can be adapted during the outsourcing contract’s term. It must ensure that it receives the services at a certain level of quality and on an agreed cost basis. The supplier must specify what service levels it can provide based on its previous experience. The services specification is the benchmark for the calculation of the services to be provided and the fees. Therefore, the outsourcing agreement typically provides for a:
Detailed description of the services in question.
Clear division of the parties’ responsibilities in relation 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 specific performance and services that 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 sufficient 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 penalties, damage claims and termination rights (see Question 21). They often include:
Escalation procedures. Re-negotiation provisions. Reaction times.
Penalties. Availability.
Standard change requests.
A set procedure for non-performance.
Service levels must be drafted clearly, as the parties can only judge the outsourcing transaction’s financial impact if they know what services will be provided. At the same time, service levels should be flexible to deal with changes over time and be modifi-able 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 customer’s typical expected damages.
CHArGInG
17. Please describe the charging methods that are commonly used on an outsourcing (for example, risk or reward, fixed price, cost or cost plus, pay as you go, resourced-based charges, use of minimum charges and so on).
Fixed-price model
This is suitable if the supplier must build a specific product, or if the scope and volume of the service can be pre-determined, and the customer wants certainty for budgeting purposes.
Flexible-price model
Flexible prices are usually based on actual accrued time, or other units.
Country Q&A
Combination of fixed- and flexible-price models
Fixed- and flexible-price models are regularly combined accord-ing to the nature of the service. Typically, a fixed price is chosen to provide the basic service, and additional services are charged on a flexible basis.
Cost plus
Cost plus is the payment of the actual costs incurred, plus an additional agreed profit margin for the supplier. The parties must include mechanisms for cost determination and review, such as benchmarking and automatic adjustments.
risk or reward
The supplier is rewarded according to its performance. If less than the agreed performance level is reached, the supplier is paid less; if performance exceeds the agreed specifications, a bonus is paid.
18. Please briefly 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 start of the outsourcing. If so, payment is generally subject to certain conditions. The parties should agree on a partial initial payment, with further payments depending on clearly defined and determinable progress.
To spread the costs over the life of the outsourcing agree-ment. If so, the parties should include a clear provision stating which party bears the remaining unpaid implemen-tation costs if one party terminates the agreement.
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 Office 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 to 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 classification 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
The project is structured to deal with open issues or disagree-ments during the outsourcing term. The project management team controls the outsourcing’s operative level, and in addition, the parties usually implement a steering board to deal with issues that are unresolved by the project management.
Change management
Change request clauses (that is, provisions that enable a party to request changes to services or service levels from the other party) give the customer flexibility 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 define whether a significant change or merely a slight adaptation (for example, of volumes or service times) is requested. Specific flexible clauses can provide for slight adaptations, 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 specification 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.
Benchmarking
Although the supplier originally offers services and prices in line with the market, market value may change during the term of the agree-ment. To ensure that prices 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.
Country Q&A
Through a market price comparison including competitors of the supplier.
Benchmarking requires an exact definition 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 defines 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 a firm of certified accountants, typically conducts the audit. The parties must agree on:
The auditor.
The regularity of the audit. Costs.
The consequences of any deviations.
security
Appropriate security methods can include:
A bank guarantee for performance claims or for warranty claims.
A letter of comfort from the financially stable parent com-pany.
Appropriate insurance cover.
WArrAnTIes AnD InDemnITIes
21. What warranties and/or indemnities are typically included in the contract documentation?
Warranties
Parties commonly negotiate specific 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 and 16).
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 indemnification against third par-ty claims. In addition, the customer can seek indemnification against future liability regarding the insourcing of employees af-ter af-termination of the outsourcing agreement, and the supplier can request indemnification against historic liability relating to outsourced employees.
22. What limitations are imposed by national law on fitness for purpose and quality of service warranties?
Without any contractual specifications concerning the quality of the service, statutory warranties only apply if the services pro-vided do not reach at least an average level.
In relation to fitness 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 must reach a certain success rate). However, if it is a service contract, the supplier only needs to provide the service, without any warranty for the fitness for its purpose. Unless the parties agree on the specific success of the service or its fitness for a specific purpose, it is up to a court to decide whether certain services provided were intended as a works contract or as a service contract.
In a purchase contract, a warranty as to fitness for purpose varies depending on whether the:
Parties have explicitly agreed on a certain purpose. Item purchased fits the purpose contemplated under the agreement, in the absence of an explicit agreement. Item fits the purpose that the buyer usually expects when buying such an item.
Term AnD nOTICe PerIOD
23. 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, outout-sourcing contracts have a du-ration of five to ten years.
Country Q&A
24. 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. The supplier and customer can agree on notice periods.
There is no notice period for extraordinary termination with good cause under section 314 of the BGB (see Question 25). The con-tract comes to an end at the moment the notice is served, pro-vided the customer has given the supplier either a:
Warning letter.
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 the other party a phasing-out period if this is necessary to protect the other party’s interests. 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 time period after receiving knowledge of the reason for termination.
TermInATIOn AnD TermInATIOn COnseQuenCes
25. What events are considered sufficient under national lawto 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 parties’ mutual interests, continuation of the agreement is unacceptable for the terminat-ing party. The other party’s default is not required.
A termination right for insolvency is subject to section 119 of the Insolvency Act (Insolvenzordnung (InsO)). An agreement is invalid if it excludes or restricts either the:
Insolvency procedure.
Insolvency administrator’s freedom to choose whether he wishes to fulfil a contract.
26. 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 fixed term. This agreement may contain provisions re-garding a compensation payment for early termination.
The outsourcing agreement commonly sets out grounds for ex-traordinary termination. 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.
27. 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 specific terms of the licence. The customer usually does not grant a licence post-termination unless there are certain ben-efits to doing so. In the absence of any specific provisions, it is generally implied that the licence terminates when the outsourc-ing agreement terminates.
28. 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 this know-how is protected by confidentiality agreements or as a business secret of the supplier.
lIABIlITy
29. 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, profit or revenue?
Liability can be, and usually is to a certain extent, contractually excluded unless it is mandatory under law. Mandatory liability includes intentional acts and claims based on product liability. If the parties have agreed on certain penalties relating to service levels (see Question 21, Warranties), liability clauses should re-flect these penalties. 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.
Country Q&A
30. Are the parties free to agree a cap on liability? If so, how is this usually fixed?
The parties are free to agree a cap on liability unless liability is mandatory under German law (see Question 29).
Liability is typically limited to a fixed amount or a percentage of the contract value, or a combination of these. The supplier will aim to:
Have different caps in place for gross and slight negligence. Exclude liability for indirect and consequential damages, and loss of profit.
TAx
31. 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 significant tax issues?
Transfers of assets to the supplier
Tax liabilities depend on whether the outsourcing is structured as an asset or a share deal (see Question 3, 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 either:
Prevent revealing hidden reserves.
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 Reorganisation Tax Act ( Umwandlungss-teuergesetz (UmwStG)).
Stamp duty of up to 3.5% can arise on real property transfers.
share deal. In a share deal, tax implications depend on the
cus-tomer’s legal form. 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. 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, it takes on all the customer’s responsibilities towards those employees (see Questions 7 and 8).It must withhold in-come tax and social security contributions from the employees’ salaries, 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 (19%).
Generally, certain services provided by banks and financial in-stitutions are exempt from VAT (section 4, No. 8 VAT Code (Um-satzsteuergesetz (UstG))). If a financial institution outsources financial services to the supplier, there is a risk that the services provided by the supplier may not fall within the tax exemption and that VAT obligations will arise. According to a recent decision by the Federal Finance Court dated 12 June 2008, the supplier must fulfil the specific and material obligations of distinct tax-exempted bank or finance service to qualify for a tax exemption. This has become a significant issue in the financial services sec-tor and should be carefully examined in each particular case.
Other
There are no other significant tax issues.
COnTrIBuTOr DeTAIls
stephan rippert and Katharina WeimerReed Smith LLP
T +49 89 2030 410
F +49 89 2030 4199
W www.reedsmith.com
