Outsourcing: Germany overview
A Q&A guide to outsourcing in Germany.
This Q&A guide gives a high-level overview of legal and regulatory requirements on different types of outsourcing; commonly used legal structures; procurement processes; and formalities required for transferring or leasing assets. The article also contains a guide to transferring employees; structuring employee arrangements (including any notice, information and consultation obligations); and calculating redundancy pay. It also covers data protection issues; customer remedies and protections; and the tax issues arising on an outsourcing.
To compare answers across multiple jurisdictions, visit the Outsourcing Country Q&A tool.
This article is part of the global guide to outsourcing. For a full list of contents, please visit www.practicallaw.com/resources/global-guides/outsourcing-guide.
There is no legal definition of the term "outsourcing" and German statutory law does not regulate outsourcing transactions in a general way. The applicability of the existing legal provisions, such as the German Civil Code (Bürgerliches Gesetzbuch) (BGB), employment, data protection or other specific laws, depends on the industry sector, the activities to be outsourced and the selected outsourcing structure. The term "outsourcing" (the English language term is used in Germany as well, and no equivalent German language term exists) does not yet appear in German statutory law at all.
Statutory law. Depending on the nature of the financial services that are outsourced, the following legal provisions apply:
The German Banking Act (Kreditwesengesetz) (KWG).
The German Securities Trading Act (Wertpapierhandelsgesetz) (WpHG).
The German Investment Code (Kapitalanlagegesetzbuch (KAGB), the former Investmentgesetz (InvG)).
Outsourcing of payment transactions and credit processing services are governed by:
Section 25a KWG, which states the general organisational duties with which a financial institution must comply. These requirements must be complied with in any outsourcing of relevant activities.
Section 25e KWG, which states the requirements to be met by any intermediary (such as brokers or agents) that is engaged by a financial institution in this context.
Section 25b KWG, prescribing the specific organisational duties to avoid additional risks in case of the outsourcing of "substantial" activities.
According to Section 25b II KWG:
core management duties cannot be outsourced and delegated to the supplier; and
the customer, as outsourcer, stays responsible to ensure compliance with all the relevant legal requirements.
For the outsourcing of securities and capital investment services:
Section 33 WpHG refers to the general duties of Sections 25a and 25e KWG and, in addition, prescribes organisational duties for institutions providing security investment services in terms of Section 1 WpHG. Special provisions regarding outsourcing transactions are contained in Sections 33 II and III WpHG.
For institutions providing capital investment services, according to Section 1 KAGB, the outsourcing of business activities is regulated in Section 36 KAGB.
Administrative regulations. The Federal Financial Services Authority (Bundesanstalt für Finanzdienstleistungen) (BaFin) is the supervisory authority for financial institutions listed in Section 1 KWG. BaFin is entitled to make orders vis-à-vis financial institutions and their directors to ensure the proper and legally compliant execution of financial services (Section 6 III, KWG).
It publishes circulars (Rundschreiben) on a regular basis which inform the supervised financial institutions about the agency's practices in applying the relevant regulatory framework. Such circulars are not legally binding on their own. However, they represent the BaFin's opinion on the interpretation of the relevant legal provisions and aim to provide guidance for the supervised companies in connection with their activities.
Since the first circular 11/2001, referring to outsourcing transactions of financial institutions under Section 25b KWG (dated 6 December 2001 and at that time still Section 25a), several circulars have been published by BaFin to specify and further refine the legal requirements.
In this context the Mindestanforderungen für das Risikomanagement (the so-called MaRisk) have been published for the first time in circular 18/2005 (dated 20 December 2005). The MaRisk are instructions given by the BaFin specifying the minimum requirements for risk management in German financial institutions. They have been updated most recently in circular 10/2012 (dated 14 December 2012). See www.bafin.de.
There are no additional legal provisions regulating the outsourcing of business processes (such as human resources, accounting or others). The general provisions apply (see Question 3).
IT and cloud services
Data protection and security law has significant relevance for the outsourcing of IT and cloud services.
In addition to IT and cloud service outsourcing, data protection and security law has significant relevance for the outsourcing of telecommunications.
There are special legal requirements for tender and procurement procedures that need to be observed if the outsourcing entity belongs to the public sector.
The following statutes and administrative regulations apply, if the contract volume exceeds certain thresholds:
German Act Against Competition Restriction (Gesetz gegen Wettbewerbsbeschränkungen) (GWB).
German Regulation on the Award of Public Contracts (Vergabeverordnung) (VgV), referring to the special contracting rules for award of public services, namely of:
construction services (Vergabe- und Vertragsordnung für Bauleistungen) (VOB/A);
public supplies and services (Verdingungsordnung für Leistungen) (VOL/A); and
professional services (Verdingungsordnung für freiberufliche Leistungen) (VOF).
German Directive for the Areas of Transport, Water and Energy (Sektorenverordnung) (SektVO).
EC law has (where applicable) precedence over the German provisions and must be considered when interpreting national law, especially with regard to the relevant thresholds.
The primary laws are:
The Treaty on European Union (TEU).
The Treaty on the Functioning of the European Union (TFEU) and the stated fundamental freedoms.
The relevant secondary laws are:
Directive 2014/23/EU on the award of concession contracts.
Directive 2014/24/EU on public procurement.
Directive 2014/25/EU on procurement by entities operating in the water, energy, transport and postal services sectors.
Insurance companies. There are specific statutory and administrative regulations for insurance companies, particularly:
The German Insurance Supervision Act (Versicherungsaufsichtsgesetz) (VAG), which has been subject to significant law changes beginning of 2016.
BaFin circular 3/2009 (VA) (dated 22 December 2009).
Similar to financial institutions, insurance companies, as defined in Section 7 No. 33 and No. 34 VAG, are supervised by the BaFin (Section 1 I, VAG). Since the most recent law changes have come into effect, outsourcing (Ausgliederung) in the insurance sector is defined in Section 7 No. 2 VAG and is specifically regulated in Section 32 VAG.
According to Section 8 VAG, insurance companies must have BaFin's permission to operate insurance businesses. Section 11 VAG states the reasons to refuse such permission.
A key principle is stated in Section 8 IV VAG, that is, that different types of insurance services cannot be covered by one single entity (Spartenprinzip). The provision of various insurance services is only possible for insurance groups that have individual entities for every type of insurance service. Each insurance service needs separate permission under Section 8 VAG. This principle needs to be considered when it comes to outsourcing activities like sales and distribution, inventory management, accounting and others.
Outsourcing transactions include various legal requirements. The fact that operating parts of the outsourcing company might be transferred to another legal entity means that questions can arise in the fields of contract and property law, company and employment law, competition law, intellectual property law, data protection and securities law or tax law.
Therefore several statutes can be relevant for outsourcing in any industry sector, particularly:
Contract and property law, particularly:
The German Civil Code (BGB);
The German Land Register Code (Grundbuchordnung) (GBO) in case of real estate transfers.
Company and employment law, particularly:
The German Transformation Act (Umwandlungsgesetz) (UmwG);
The German Works Constitution Act (Betriebsverfassungsgesetz) (BetrVG).
Competition law, particularly the German Act Against Competition Restriction (GWB).
Intellectual property law, particularly the German Copyright Act (Urhebergesetz) (UrhG) in case IP rights are transferred.
Data protection and securities law, particularly:
The German Data Protection Act (Bundesdatenschutzgesetz) (BDSG); and
The German Telecommunications Act (Telekommunikationsgesetz) (TKG).
Tax law, particularly the German Reorganisation Tax Act (Umwandlungssteuergesetz) (UmwStG).
Section 33 III of the German Securities Trading Act (WpHG) applies to securities investment companies. Outsourcing of portfolio management services for private customers to a supplier outside the EU/ EEA must be notified to the Federal Financial Services Authority (BaFin) if there is no co-operation agreement between the BaFin and the responsible supervisory authority in the non-EU/EEA country under which the supplier is authorised for the service.
Section 36 VI of the German Investment Code (KAGB) applies to capital investment companies. The supplier must notify the BaFin of any planned subcontracting ("under-outsourcing") prior to the subcontract coming into effect. Moreover the customer must have previously agreed to the under-outsourcing, and all the requirements of Section 36 No. 2-8 of the KAGB must be complied with.
According to the provisions of the VAG, insurance companies need the BaFin's permission for contracts regarding the transfer of insurance portfolios from one insurance company to another (Section 13, VAG) and for transformation of an insurance company under Sections 1 and 122a UmwG (Section 14, VAG).
Section 39 of the German Act Against Competition Restriction (GWB) applies to mergers. If the outsourcing qualifies as a merger under of Section 35 and 37 of GWB, it is subject to merger control by the Federal Cartel Office (Bundeskartellamt) and must be notified with this authority according to Section 39 of GWB.
There are several categories of outsourcing structures that can overlap, depending on the scope of an outsourcing project.
The customer directly enters into an outsourcing contract with the supplier. The supplier will perform the relevant services with his own infrastructure and employees and therefore receive remuneration from the customer.
The outsourcing contract can be set up as a framework agreement defining the scope and general provisions, such as contract period, termination rights, liability, IP rights, confidentiality and data protection, whereas individual contracts under this framework agreement regulate the details for the individual services provided.
Direct outsourcing can be implemented relatively quickly.
The calculation of costs is easy as they are pre-defined.
The customer benefits from the supplier's expertise.
Costs can be very high.
The customer's control over the supplier is limited (he or she only has contractual rights).
There is significant dependence of the customer on the supplier.
Activities of the customer are outsourced to different suppliers. This is usually realised by the customer entering into direct outsourcing contracts with each supplier. If co-operation between the suppliers is required, the contract must regulate whether they will be jointly responsible for the performance of services. Moreover the relevant contracts must define whether such co-operation will be exercised directly between the suppliers (which is less elaborate for the customer) or via the customer (which provides more control for the customer).
Compared to direct outsourcing with only one supplier, the customer is less dependent on the supplier.
Competition between the suppliers can reduce the prices for service provision.
Co-ordination and governance of various suppliers can be time-consuming and expensive for the customer.
The customer's control over the supplier is limited (he or she only has contractual rights).
The customer enters into an outsourcing contract with the supplier and the supplier then subcontracts with a third party (usually offshore) who will provide the relevant services or parts of it to the customer. As personal data might be transferred to, and processed by, the subcontractor, a data processing agreement between the customer and the subcontractor can be required.
Service provision by offshore subcontractors usually is cost efficient.
Co-ordination of the subcontractors is mainly exercised by the supplier who is the contractual partner of the customer.
A disadvantage is that control over the subcontractors is difficult for the customer.
A separate entity is set up by the customer and the supplier to perform the relevant services. Such an entity is jointly owned or governed by the customer and the supplier and each party contributes with, for example, employees, know-how or infrastructure.
There is no such lack of influence and control as in outsourcing structures that are only based on contractual relationships.
The close co-operation can increase the quality of service provision.
The entity must be managed jointly, which might be cost-intensive and time-consuming.
There is less flexibility compared to contract-based outsourcing structures.
This is a form of group-internal sourcing. Activities are transferred to a subsidiary wholly-owned by the outsourcer. To provide services of high quality, the subsidiary is often supported by external consultants (on a contractual basis).
An advantage is that the outsourcer has full control over his subsidiary.
Competent personnel need to be hired by the outsourcer itself.
External consultants are expensive.
Build operate transfer
The supplier independently builds up an operation (an entity) for the provision of the relevant services and then transfers this facility to the customer.
An advantage is that the customer ensures the operation is "ready to use".
A disadvantage is that this outsourcing structure is usually quite expensive.
Request for proposal
In a request for proposal (RFP) the customer directly submits his expectations (such as the scope and service levels) of a possible future outsourcing to the supplier. The RFP is the basis for a first proposal of the supplier.
Invitation to tender
The customer invites several suppliers to provide their proposals according to his predefined expectations. Customers hope for strong competition between the suppliers to get the best possible price, the highest quality and the most experienced service providers.
The customer needs to clarify whether the respective outsourcing is subject to special legal provisions (such as notification duties) and whether the supplier can fulfil all legal requirements.
On the other hand, the supplier needs to examine the scope of the outsourcing and all assets that might be transferred to him, to ensure his capability to exercise his duties in a legally compliant way.
Transferring or leasing assets
Formalities for transfer
Section 311b I 1 of the German Civil Code (BGB) states that any contract stating one party's obligation to transfer its immovable property must be notarised to be effective. A lack of notarisation can be dealt with if the requirements of Section 873 and 925 of the BGB are fulfilled.
Section 873 and 925 of the BGB states that the transfer of immovable property (in rem) is realised by an agreement between the parties in front of a notary or another competent authority and the registration of the transfer in the German Land Register (Grundbuch).
Section 883 of the BGB states that registration of a priority notice (Vormerkung) in the land register is recommended, to avoid bona fide transactions (Section 992, BGB) of the immovable property to third parties.
IP rights and licences
Section 30 of the German Patents Act (Patentgesetz) (PatG) and Section 4 No. 1; 27 III; 28 of the German Trademark Act (Markengesetz) (MarkenG) cover IP rights and licences. Patents and trademarks are registered with the German Patent and Trade mark Office (Deutsches Patent- und Markenamt). Transfers must be registered as well to enable the new patent or trademark holder to take legal action with regard to the patent.
For the transfer of movable property there are no general formalities to observe. However, the relevant objects must be defined exactly, especially when it comes to the transfer of various movable objects, for example in an asset deal.
Section 398 of the BGB regulates the transfer of individual claims but not of entire contracts. However contracts can be transferred to third parties with the consent of the original contractual partner.
Data and information
The transfer of personal data is permitted only to the extent that the provisions of the German Data Protection Act (BDSG) allow such a transfer (Section 4, BDSG). See Question 18.
Transfers of goods from and to the outside of the EU/EEA might be subject to restrictions for import and export, according to Section 4 of the German Foreign Trade Act (Außenwirtschaftsgesetz) (AWG) and respective administrative directives.
Formalities for leasing or licensing
For leasing or licensing no special formalities must be observed to make it effective. However, it is recommended that the respective contracts are in a written form for reasons of clarity and evidence.
According to Section 550 of the German Civil Code (BGB), a residential lease agreement (entered in a non-written form and for a term of more than one year) is assumed to be concluded for an indefinite period. That means that a non-written termination date is invalid in such a lease agreement. Termination is then possible after one year at the earliest, and has to be declared expressly according to the general provisions. The form of the lease agreement is irrespective of its effectiveness in total and only affects the validity of the termination date.
IP rights and licences
Data and information
Data and information
Transfer by operation of law
Section 613a of the German Civil Code (BGB) implements employee protection based on Directive 2001/23/EC on safeguarding employees' rights on transfers of undertakings, businesses or parts of businesses (Transfer of Undertakings Directive).
In case of a business transfer, the employees' contracts of the business are transferred to the transferee, potentially including collective agreements tied to these contracts. A business transfer is defined as a long-term economic unit retaining its identity despite being transferred. Whether a long-term economic unit was transferred and whether it retained its identity is determined by the courts on a case-by-case basis, which is, based on the following criteria:
The type of business (for example where it is an industry, trade, service and so on).
The transfer of tangible assets (such as buildings and movable goods).
The value of intangible assets at the time of the transfer.
The transfer of the main staff.
The transfer of clients or customers.
The degree of similarity of the business before and after the transfer.
The duration of any interruption to the business.
Change of supplier
In case of a change of supplier, the above applies respectively as far as this change constitutes a business transfer (see above, Initial outsourcing).
If outsourcing is terminated and therefore operations are being insourced again, the above applies respectively as far as this insourcing constitutes a business transfer (see above, Initial outsourcing).
For more information on transferring employees on an outsourcing, including structuring employee arrangements (including any notice, information and consultation obligations) and calculating redundancy pay, see Transferring employees on an outsourcing in Germany: overview.
Data protection and secrecy
Data protection and data security
General requirements. The German Data Protection Act (BDSG) is the general statute for data protection law and contains protective provisions regarding the collection, processing and use of personal data (Section 1 II, BDSG). It is subsidiary to various special law statutes regulating data protection in individual fields of law, such as the German Telecommunications Act (TKG) or the German Telemedia Act (Telemediengesetz) (TMG) for telecommunications.
The most important principle is that the collection, processing and use of personal data is forbidden, except if it is expressly allowed because of the consent of the data subject or by law (Section 4 I, BDSG).
Companies fulfilling the qualifications of Section 4f of BDSG have to appoint a data protection officer.
Companies must ensure their employees observe data secrecy rules (Section 5, BDSG).
If data processing is executed by a supplier on behalf of, and strictly bound by, the instructions of the customer, the latter stays responsible for the protection of processed personal data (Section 11 I, BDSG) whereas the supplier's duties are limited (Section 11 IV, BDSG). In such a case the transfer of data to an EU/EEA-based supplier does not qualify as a transfer to a third party in terms of Section 3 IV No. 3, BDSG and therefore not restricted (Section 3 VIII, BDSG).
The level of data protection inside the EU/EEA and in some countries named by the European Commission (for example, Canada, Switzerland or Argentina) is assumed to be adequate. Therefore the same rules apply as for data processing inside Germany.
Data processing outside the EU/EEA is subject to further restrictions. It is only permitted:
With the consent of the data subject (Section 4c I No. 1, BDSG).
If the transfer is necessary or mainly in the interest of the data subject (Section 4 I No. 2-6, BDSG).
With the permission of the supervisory authority (Section 4c II, BDSG). Permission can be given if the supplier provides an adequate protection of privacy rights particularly by implementation of contractual clauses or corporate rules.
Furthermore on an EU/EEA-level there are measures legalising data processing to a country that does not have an adequate data protection level:
Implementation of EU-Model Clauses into the contractual relationship between service provider and customer.
Implementation of Binding Corporate Rules by multinational companies for international transfers of personal data within the same corporate group to entities located in countries that do not provide an adequate level of protection.
It should be noted that the Safe Harbour Decision of the EU Commission has been declared ineffective by the ECJ in a judgment of the 6 December 2015 (C-362/14, Schrems).
Security requirements. Data security requires confidentiality, availability, integrity and verifiability of data. Public or private institutions collecting, processing or using personal data must take the appropriate technical and organisational actions to meet those requirements and to comply with their data protection duties (Section 9, BDSG).
There is no uniform data security law in Germany but individual regulations in several special-law provisions such as Sections 201 to 206 or Sections 303a and 303b of the German Criminal Code (Strafgesetzbuch) (StGB). As far as IT security measures enable an employer to instruct or control his employees, the co-determination rights of Section 80 of the German Works Constitution Act (BetrVG) become relevant.
Mechanisms to ensure compliance. Section 11 II of BDSG provides certain key points to be regulated in a data processing contract. Audit and other control rights of the customer, as well as notification duties of the supplier for breaches of data protection law must be contractually implemented.
International standards. The ISO/IEC 27001 (Information technology, security techniques and information security management systems requirements) is an international information security norm. Organisations can obtain an ISO certificate, stating their compliance with the respective standards.
Sanctions for non-compliance. Besides the special law provisions (StGB), Sections 43 and 44 of BDSG impose fines and penalties for non-compliance.
General requirements. In Germany there is no statutory regulation for banking secrecy. It is based only on the contractual duty of secrecy of a bank vis-à-vis its customer (the definition is in the General Terms and Conditions for Banks) (AGB-Banken). Nevertheless it is a recognised principle of customary law. There are reporting and disclosure obligations for banks, for example in the field of tax law, limiting the principle of banking secrecy. Banking secrecy and data protection law (BDSG) exist and may apply in parallel.
Mechanisms to ensure compliance. If a bank aims to outsource activities to a supplier (Question 2), it must implement the contractual obligations of the supplier to comply with banking secrecy duties.
Sanctions for non-compliance. The violation of banking secrecy is a breach of contract and may entail damages. Section 203 of the German Criminal Code (StGB) is not applicable for banks.
Confidentiality of customer data
General requirements. Trade secrets are protected under the Act against Unfair Competition (Gesetz gegen den unlauteren Wettbewerb) (UWG).
Mechanisms to ensure compliance. The customer and supplier must implement contractual confidentiality clauses in the outsourcing contract and regulate in detail, if and how confidential information of one party may be transferred and used by the other one.
Sanctions for non-compliance. Sections 16 to 20 of UWG impose criminal penalties and fines for certain violations. A breach of contractual confidentiality duties can entail damages.
Service specification and levels
Usually the customer defines the requirements on service provision and the supplier evaluates whether he can provide such a service level. On this basis the parties agree on a detailed service level agreement (SLA) specifying the scope and quality of services, the responsibilities of the parties and the fees.
As an outsourcing project may cover various services, each of them needs to be defined in a service level agreement (SLA). Such SLAs are usually added as annexes to the main or framework contract. This facilitates adaption or a change of service levels during the term of outsourcing without the need to change the whole contract.
An SLA typically covers (among others):
Availability and quality of service.
Monitoring and reporting rights and duties.
Damages in case of non-performance.
Flexibility in volumes purchased
The parties can agree to adjust the volumes of services provided under the outsourcing contract during the contract term. Such an adjustment is unproblematic when it is made by bilateral agreement. If parties want to allow a unilateral adjustment it is recommended (especially for the supplier) to agree on a certain maximum or minimum volume to avoid a lack of capacities.
If adjustment clauses are qualified as general terms (Section 305 I, German Civil Code (BGB)) they are subject to several restrictions of Sections 305 ff of BGB. Particularly, the clauses cannot be unexpected or disadvantageous for the other party.
Charging methods and key terms
Parties are allowed to choose any charging methods they consider appropriate. The following charging methods are typical examples and can be combined or may overlap:
Fixed price. A fixed price for outsourcing services is suitable if the scope and volume of the project are clearly pre-determined. Adjustments of the scope or volume during the contract term can be difficult as they usually entail adjustments in the pricing.
Flexible-price/pay as you go. This charging method suits if the scope and volumes are not predictable from the beginning. For example, if services are provided on demand and efforts depend on the respective request of the customer. Pricing can be tied up with the resources (for example, the cost of time or material) a supplier has to spend for an adequate service provision. Hourly rates or material costs are often based on a rate card as a schedule of fees for each service in the contract.
Risk or reward. This charging method is linked to the service level agreement (SLA). If the supplier does not meet the service levels agreed between the parties he will be paid less. On the other hand, the supplier can be rewarded for over-fulfilling his contractual duties (for example, 100% availability of services instead of the agreed 99.98%).
Cost plus. Prices are calculated by the actual costs the supplier must bear when providing the services plus a fixed profit margin for the supplier. A decrease in the costs is beneficial only for the customer, whereas an increase of costs can be directly charged to him by the supplier.
Customer remedies and protections
If the supplier fails its obligations, the customer's rights depend on the nature of the contract and if there are special provisions, for example for purchases (Sections 434 ff., German Civil Code (BGB)), leases (Sections 536 ff., BGB) or contracts for work (or works contracts or Werkvertrag) (Sections 634 ff. BGB).
However there are provisions generally applicable for mutual contracts, particularly under Sections 320 ff. BGB. The customer can:
Refuse to pay the price until the supplier performs its obligations (Section 320, BGB). This is also applicable if the customer is contractually obliged to pay in advance but there is legitimate doubt about the ability of the supplier to perform (Section 321, BGB).
Claim supplementary performance from the supplier and if the latter fails to do so within an adequate period, the customer can withdraw from the contract (Section 323, BGB).
Claim damages or compensation for wasted expenses from the supplier (Sections 280 ff. and 284, BGB).
For some contract types, for example purchase contracts (Sections 437 No. 2 and 441, BGB), lease contracts (Section 536, BGB) or contracts for work (Sections 634 No. 3 and 638, BGB), it is possible to reduce the price instead of withdrawal. Faulty performance of a contract for work can allow the customer to take the necessary measures himself at the expense and risk of the supplier (Selbstvornahme) (Sections 634; 637, BGB).
Customer protection clauses can go beyond the rights granted by law. As discussed in Question 13, clauses that are considered as general terms and conditions (Sections 305 ff., German Civil Code (BGB)) are subject to restrictions, for example if such clauses are not sufficiently transparent or are disadvantageous to a party. Disadvantages can result, for example, from the supplier's work being inadequate or an impending violation of the supplier's trade secrets caused by such clauses.
Customer protection clauses can include:
A detailed service level agreement (SLA) including a discount for the supplier's performance on a lower service level than agreed. Such discounts can become relevant even if the level of faulty performance in terms of law is not reached and statutory warranty claims could not be exercised (see Question 20).
Financial penalties or more extensive damages to pay by the supplier for any injuries.
Benchmarking processes to examine the comparability of prices offered by the supplier with the customary market level. The details and consequences have to be defined (such as whether to include automatic price adjustments, termination rights, and so on) (see Question 21).
Audit rights for which it is important to determine the details, such as the choice of the auditor, the costs, the regularity of audits and the consequences in case any breaches occur.
Security clauses regarding, for example, bank guarantees or insurance covers of the supplier.
Exit management provisions to ensure a proper handling (and return) of transferred assets after contract termination so that the customer may continue its business without restrictions.
Warranties and indemnities
The warranties implied by law are usually supplemented and/or modified by the parties. Therefore the parties are flexible to a large extent, but apart from legal restrictions (Sections 305 ff., German Civil Code (BGB)) it is useful to strive for a balance of interests.
The parties might be particularly interested in:
An extension or shortening of the legal time limits for the supplier to provide remedies in case of faulty performance.
A determination of remedies and methods.
An extension or shortening of the legal time limits for the customer to raise claims.
An express regulation of special indemnities, for example for a breach of confidentiality or violation of IP rights.
An exclusion (or express granting) of warranty rights that are (or are not) granted by law, for example, a right to reduce charges.
An exclusion of warranty rights if one party fails to contribute properly to the fulfilment of the contract.
Indemnification caps for certain claims out of warranties.
The transfer of a party's warranty claims against third parties.
If the parties do not specify the expected quality and fitness for purpose of the service, the law basically requires a performance of an average type and quality (Section 243, German Civil Code (BGB)).
The concrete performance depends of course on the contract type.
Sections 434 and 435 of BGB deals with purchase contracts where the purchased item is free from defects (of material or title). According to Section 434 I 1 of BGB contractual quality agreements prevail. In the absence of such agreements, the purchase item's quality is assumed to be appropriate if it either fits the purpose indicated by the contract or, without such an indication of quality, it corresponds to what the buyer might usually expect when buying such an item.
In outsourcing projects under German law, the differentiation between the works contract (Section 633, BGB) and the service contract (Dienstvertrag) (Section 611, BGB) is very important. Under a works contract, the supplier owes a specific result (success), whereas under a service contract he only owes the execution of certain activities. Suppliers are typically interested in entering service contracts as they do not grant warranty rights for a success, whereas customers usually try to give the agreement a works contract structure. Outsourcing contracts can have both elements, for example if they contain a detailed service level agreement (SLA) for the main services (success owed) as well as the supplier's duty to hold training or instructional meetings for the customer (activity owed).
Contribution and information rights in the contract are effective for the supplier to establish warranty claims on the participation of the customer (for example, the provision of sufficiently qualified employees or adequate locations for service provision).
Parties may wish to further modify the statutory regulations, for example regarding indemnity and interest for default, or amending the risk or limitation periods for claims arising under the contract.
Regarding employee arrangements see Transferring employees on an outsourcing in Germany: Question 7.
Apart from the legally necessary types of insurance (such as accidental or pensions insurance for employees), the insurance protection of a company depends on the type of business it has.
The following insurance types are often included:
Third-party liability insurance, including:
directors' and officers' liability;
business liability; or
Depending on the type of outsourcing, the parties may be interested in the transfer of insurance from the customer to the supplier.
Term and notice period
There is no explicit statutory regulation of a notice period for the termination of outsourcing contracts and contractual variation is possible.
Section 314 of the German Civil Code (BGB) states a general right to terminate continuing obligations for a "good cause" (that is, for a material breach), which is subsidiary to special termination rights for a good cause (for example Section 626, BGB for service contracts). Notice of termination for a good cause must be given within an adequate time period after the party has become aware of the good cause. See Question 24.
Moreover there are statutory regulations stating notice periods for ordinary termination (Section 624, BGB). Notice periods for ordinary termination vary depending on the contract type.
The effectiveness of contractual notice periods can be subject to the restrictions of Sections 305 ff. of BGB. The courts evaluate each individual case.
Termination and termination consequences
Events justifying termination
Termination for good cause (that is, termination for a material breach) is possible if the maintenance of a contractual relationship becomes unacceptable for a party. To decide on this unacceptability, all individual circumstances and mutual interests of the parties must be considered. The law therefore gives examples for special contract types (Section 543 II, German Civil Code (BGB)).
The German Insolvency Act (Insolvenzordnung) (InsO) contains legal provisions regarding the continued existence or termination of contractual obligations in case of insolvency (Sections 103-118, InsO). Those regulations may not be contractually excluded or limited by the parties in advance (Section 119, InsO).
Termination for convenience
Ordinary termination (that is, termination for convenience) is possible as soon as the contract's term has expired or, in the absence of such term, at any time. It is tied to an adequate notice period which can be agreed on by the parties.
Section 313 III of BGB grants a termination right in case the contract basis no longer exists (Wegfall der Geschäftsgrundlage) and there is no acceptable way for both parties to adopt the contract to the new circumstances.
The parties are free to agree on further termination rights. Although in some fields of special law or for some contract types there might be restrictions (for example, in the lease of living space). Parties can agree on a right to terminate the contract before the expiry of the contract term. A compensation payment for early termination is usually then agreed upon.
IP rights and know-how post-termination
Usually the customer has no right to use the supplier's know-how after termination of the outsourcing. However such a right can be contractually granted.
It might be useful for the customer to agree on a phasing-out period or a know-how transfer after termination to make sure that business can be carried on properly. In the absence of such contractual clauses it can only be for reasons of good faith that the supplier might be obliged to support the customer.
The supplier's know-how may be transferred in effect to the customer if the latter insources employees of the supplier. This depends on the employees' confidentiality obligations and does not apply for protected business secrets of the supplier.
Liability, exclusions and caps
There are different legal requirements for the effectiveness of liability exclusion clauses in individually negotiated contracts and in contracts qualified as general terms (Sections 305 ff., German Civil Code (BGB)).
In individual contracts the parties are free to exclude liability as far as the law does not prescribe mandatory liability:
Section 276 III of BGB generally prohibits the exclusion of liability for intentional injury. That means that liability for negligence can be restricted or excluded (subject to further special provisions).
Liability for injury to life, body or health cannot be excluded or restricted.
Product liability under the Product Liability Act (Produkthaftungsgesetz) (ProdHaftG) may not be contractually excluded or restricted (Section 14, ProdHaftG).
Warranty rights for defective goods can be excluded if the defect is not fraudulently kept secret and the absence of defects is not guaranteed by the debtor (Section 444, BGB for purchase contracts; Section 639, BGB for works contracts). However, single liability provisions are expressly mandatory (Sections 536 IV; 574 IV, BGB).
Liability exclusions may not be immoral (Section 138 I, BGB).
For contracts qualified as general terms there are additional legal restrictions.
According to Section 309 No. 7 of BGB liability is mandatory and may not be restricted or excluded for:
Intentional or negligent injury to life, body or health.
Intentional or grossly negligent damage to other goods
Section 309 No. 8 of BGB contains further limitations for liability exclusion or restriction.
Liability caps are only permitted if liability can be restricted (see Question 29).
They usually refer to a certain percentage of the contract volume and/or to a fixed amount. Parties can differ between categories of injuries (for example, property damages or pecuniary loss, direct or indirect/consequential damages) and the level of fault (for example, gross or normal negligence).
Usually the parties are primarily interested in out-of-court dispute resolution. Therefore in the context of escalation management, negotiation and mediation processes can be contractually implemented.
For judicial disputes the contract commonly contains a jurisdiction agreement and a clause stating the applicable law. The parties can also chose an arbitration clause regulating the responsible arbitration court and the applicable arbitration rules.
Transfers of assets to the supplier
The German tax treatment of the transfer of assets depends on how the outsourcing is structured. For example, for internal or external outsourcing or outsourcing via an asset deal, share deal or a reorganisation under the German Reorganisation Tax Act (UmwStG), if the IT system is transferred by way of an asset deal, the gain being the difference between the sales price and tax book value is generally taxed at ordinary rates. In case of a transaction under the UmwStG, a taxable gain realisation can be avoided if specific requirements are met. If the transfer is executed by way of a share deal, a gain realisation would occur with respect to the shares rather than with respect to the single assets. If certain criteria are met, the gain realised upon a share transfer may be 95% tax exempt under the participation exemption regime. Where outsourcing happens within a group of related parties, the transaction needs to be structured at arm's length conditions in order to avoid income adjustments.
If the outsourced IT system qualifies as a separate business unit the receiving entity will generally become secondarily liable for certain taxes of the transferring entity where the tax liability results from the operation of the business (for example VAT and trade tax).
Transfers of employees to the supplier
As a result of the transfer of employees to a new employer, generally the new employer will become obliged to comply with the wage tax withholding and reporting obligations in respect of the transferred employees.
The transfer of employees usually also results in the transfer of pension obligations related to the transferred employees. The transfer and assumption of pension liabilities is subject to specific German income tax rules. For the entity assuming the pension liabilities, a step down of the liabilities may be required which may result in a taxable gain realisation.
VAT or sales tax
The transfer of assets may be subject to VAT and therefore could trigger VAT in Germany. However, if the transfer of the assets qualifies as a transfer of a going concern, the transaction would be non-taxable for German VAT purposes.
After the outsourcing has become effective, the relevant services will be procured from the acquiring legal entity. These supplies may be subject to VAT as well.
If the entities involved in the outsourcing transaction do not form part of the same VAT group within Germany (for example, because the supplying entity is completely independent or only remotely integrated in a potential parent company), the VAT implications need to be assessed for the individual services rendered. General questions would include the VAT-relevant place of service and whether a VAT exemption might apply. Further, the entity receiving the outsourced services might incur an additional compliance effort, as it might have to recover input VAT from the German tax authorities or report reverse-charge turnover.
If both entities form part of the same VAT group within Germany (for example, because both entities are integrated in financial, economical and organisational terms), any transactions between those entities is non-taxable and the parent company remains responsible for the VAT reporting for the group company rendering the outsourced services.
Germany does not levy a general withholding tax on IT services rendered by German or non-German entities. However, under certain circumstances, at least part of the income earned by a non-German service provider from rendering the outsourced services may be subject to withholding tax in Germany if, for instance, the income comprises remuneration for granting the use or a right to use rights (for example, copyrights). There may be a reduction from, or exemption of, withholding tax available under the applicable double tax treaty, if any.
In general, there is no stamp duty in Germany or transfer taxes other than VAT that should arise in connection with IT outsourcing. However, if real estate or shares in entities holding real estate are transferred in connection with the outsourcing transaction, real estate transfer tax may arise. Depending on the municipality where the real estate is located, the tax rate varies from 3.5% to 6.5%.
The net income of a corporation subject to unlimited tax liability in Germany is generally subject to corporate income tax (at a rate of 15%) plus a solidarity surcharge (5.5% on the assessed corporate income tax) and trade tax (at a rate of between 7 to 17.5% depending on the municipality where the business is operated). Generally, the compensation paid for buying-in the outsourced IT services in future should qualify as a deductible business expense. As far as trade tax is concerned, only a partial deduction may be available if, for example, the compensation paid is regarded as remuneration for receiving a right to use rights.
In case of cross-border IT outsourcing the transaction has to be planned carefully in order to avoid the creation of unwanted permanent establishments, both from the perspective of the outsourcing entity, as well as from the perspective of the entity acquiring the IT system, and rendering services in the future. In case of intra-group outsourcing, care must be taken in particular regarding compliance with the German transfer pricing rules (both in terms of agreeing on arm's length remuneration for the transfer of the assets and the subsequent rendering of the services, as well as in terms of documenting the arm's length nature of the transactions).
Other tax issues
Germany operates rather strict rules regarding the proper maintenance and storage of books and records. Generally, the books and records of a German taxpayer are required to be kept in a complete, correct, timely and orderly manner. Furthermore, the books and records have to be kept and maintained in Germany. If certain requirements are met, and in case of prior consent from the competent tax office, the taxpayer may transfer their records to electronic bookkeeping abroad.
Description. This free database provided by the German Ministry of Justice and Consumer Protection in co-operation with juris GmbH contains almost all German federal statutory law. It is one of the most reliable websites but the only binding version of German law statutes is the paper version published in the Federal Law Gazette (Bundesgesetzblatt).
Translations of many statutes into English are available on this website, but solely as convenience translations.
Description. This database is provided by the German Ministry of Justice and Consumer Protection in co-operation with juris GmbH. It contains administrative regulations. Translations into English are not available.
Description. Official website of the German Federal Court of Justice (Bundesgerichtshof) (BGH).
Description. Dejure.org is an unofficial, free information portal for German law. It includes around 270 law statutes as well as a database containing more than one million court decisions (the full text versions are available via links to other websites).
Prof Dr Wolfgang Fritzemeyer, LLM, Partner
Baker & McKenzie
Munich / Germany
T + 49 89 5 52 38 154
F +49 89 5 52 38 199
Professional qualifications. Rechtsanwalt, Germany; Attorney-at-law, New York, US; Solicitor, New South Wales, Australia.
Areas of practice. Information technology; M&A; corporate/commercial; IT and IP transactions.
Representative clients, cases or matters
Accenture: assisted in connection with various IT-outsourcing transactions.
Adobe: acts as IT and corporate counsel for Adobe.
Bertelsmann: assisted in connection with IT matters and IT-related transactions.
First Data Corporation: acted as IT counsel, also in cross-border contract and compliance matters, for this global payment processing company.
Hewlett-Packard: acted and acts as company's counsel for a number of years and assisted in connection with various IT, including IT litigation, and corporate matters, including the take-over of Tandem and Digital Equipment by Compaq, as well as major outsourcing transactions; serves as the firm's client service director for HP.
Hutchison Telecom: acted as IT and corporate counsel and assisted in a variety of transactions.
Numerous M&A transactions for broad range of clients, especially High Tech.
Languages. German, English, French.
Professional associations/memberships. President of the German Chapter of the European Outsourcing Association since the Chapter's establishment; member of the German group of experts drafting the German Sample Electronic Data Interchange Agreement.
Publications, presentations and articles.
Various treatises and articles, mostly on IT, outsourcing, franchising and M&A law matters.
Holds regular internal and external seminars.
Lectures at the law faculties of the Universities of Constance and Munich.