Under the German civil code, contractors and clients can protect themselves against risk in several ways, but each one must be approached with caution
In principle, German building contract law is based on a simple concept: a contractor undertakes to construct a building and in turn, the employer undertakes to pay the contractor for the work done.
However, as opposed to many other types of contract provided for in the German civil code (BGB), the employer’s obligation to pay does not automatically arise when the contractor has completed the job. The employer must also be satisfied that the building has been constructed in accordance with the contract. If this is not the case, because of defects for example, the contractor cannot demand remuneration for the labour. The contractor does of course have the option of taking the employer to court in order to prove his case, but this is often a cumbersome process. This means the contractor is obliged to work in advance of payment as well as bearing the risk of insolvency on the part of the employer.
Against this background, the contractor has a vital interest in securing its claims under the building contract. The German civil code provides the contractor with a claim against the employer on the granting of a mortgage to the employer on the building property. Such a mortgage hypothetically offers the contractor security, since it can levy execution against the land in the event that the employer does not pay. However, in practice this means of security is, in most cases, economically worthless as the land is usually so encumbered with various charges prior to building work that the contractor is likely to leave empty-handed in the event of any levy of execution. In addition, such a mortgage only protects the building contractor if the employer is also the owner of the land. If the employer is not the owner, this means of security fails entirely.
In order to avoid these deficiencies, the law does provide alternative ways of protecting contractors. A contractor can set the employer a deadline within which a specific chosen type of security must be provided to the contractor, most often bank guarantees. If the employer allows the stipulated deadline to expire without having furnished the security demanded, the building contractor can refuse to carry out the work. In addition, it is only required to recommence work if it can be certain that its claims are adequately secured. Moreover, it can also assert the damages which it has incurred as a result. In this case, the law assumes that these damages amount to a lump sum of 5% of the agreed remuneration. If the contractor can prove greater damages in a specific case, however, then these damages are also recoverable.
However, it is not only in the contractor’s interests to secure its claims under the building contract. The employer obviously wants building work completed in a timely and orderly manner and without defects. It goes without saying that the employer can also secure these interests. However, the statutory law makes no express provision for the securing of the employer’s claims. Therefore if the contractor becomes insolvent the employer would leave empty-handed if he had not made any contractual provisions. For this reason, the employer’s security claims must be set out clearly and separately in the building contract. In practice, employers insist on the provision of bank guarantees. The principle is the same as in the UK: a bank guarantees the contractor’s obligations under the building contract such that, in the event of a security claim, the employer will receive a sum of money with which it can compensate for the contractor’s deficiency.
However, because of the strict provisions of German civil law, these security guarantees contain many pitfalls for the employer and are to be treated with caution. When drafting a contract, particular care must be taken to ensure that the security interests of the employer are actually satisfied. It is imperative for the building contract and guarantee to precisely state which claims are being secured by the guarantee. If this cannot be established without doubt, then the security is likely to become worthless.
This article can only give a brief outline of the issues involved with securing a claim through building contracts in Germany. It is essential that firms take legal advice before entering a contract.
Volker Bishcofs is a solicitor at Linklaters office in Cologne. Volker.Bischofs@linklaters.com.