Guarantees on first demand are a hot issue. No development is carried out without the parties having to provide security, in the form of guarantees or performance bonds (Bürgschaften). But the Federal Court of Justice caused a major upheaval in 2002 when it held that the obligation on a contractor to provide a performance bond "payable on first demand" is void if the obligation derives from the employer's standard terms. Standard terms are defined as clauses intended for repeated use by one party that are not individually negotiated.
Standard term clauses are subject to court review to determine whether they put the contractual partner of the employer (in this case the contractor) at a disadvantage. In this case, the requirement to provide a performance bond "payable on first demand" was held to be disadvantageous to the contractor, as it relieved the employer of the risk resulting from an insolvency of the contractor, exposed the contractor to the insolvency risk of the employer, and increased the danger of abuse of the security. No ruling on performance guarantees exists yet but the courts are likely to take a similar stance.
To avoid this, employers tend to follow a less is more approach and give up the requirement that the performance bond is "payable on first demand", which in turn devalues the security. The alternative is to negotiate the security clause individually and to document negotiations in a way that can be proven in court.
The advice on the Construction Contract Procedures document, or VOB, is not to attempt any changes. VOB was developed by a committee of public employers, representatives of the construction industry and technical organisations, and part B contains general conditions of contract widely used in German construction. Despite being a document containing standard terms, VOB/B does not fall under the review by courts outlined above as it is considered to be a fair and balanced set of rules that put no party at a disadvantage. Therefore, if VOB/B was agreed as a whole or without significant changes, the validity of single clauses provided by it could not be challenged in court.
However, this advantage of VOB/B has now been restricted by the Federal Court of Justice, which ruled that an agreement on the VOB/B without significant changes is not enough and that VOB/B has to be agreed without any changes. Therefore, to avoid the courts scrutinising the adequacy of single clauses, parties either have to agree on the VOB/B as a whole or go through the process of drafting and negotiating an individual works contract.
Think twice about loans from affiliated companies. In larger developments, it is not uncommon for the German subsidiaries of German or foreign parent firms to act as the main developer on a project while being part-funded by the parent company. In the past, interest on parent company loans was tax deductible as operating expenses.
But since the beginning of 2004, section 8a of the Corporate Tax Act contains strict criteria that apply uniformly for local or foreign parent company loans. If (i) the lender holds more than 25% of the shares of the borrower, (ii) the borrower pays interest or compensation for the loan exceeding €250,000 (£165,000) and (iii) the loan capital exceeds 150% of the company's own equity investment, the interest paid is considered a hidden profit distribution. As a result, it may be subject to corporate income tax of 25% plus a variable percentage of local business tax. This rule does not apply if the borrower can prove that the loan could have been obtained from third parties on the same conditions.
These three – far from exhaustive – examples highlight that it is important to be aware of the legal obstacles to developments in Germany.
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