Deconstructing the termination of construction contracts under German Law

Overview of the law

The three key considerations are: The Employer can terminate the construction contract at any time; a justified termination can trigger the Employer’s claims for damages and reimbursement of replacement costs; and a termination without cause can trigger the Contractor’s remuneration claims.

What is the German law regarding construction contracts

German law governs the construction contract as part of the German Civil Code[1] (“Bürgerliches Gesetzbuch” (BGB)).

Additionally, the German Construction Contract Procedures (“Vergabe- und Vertragsordnung für Bauleistungen, Teil B” (VOB/B)) contain contractual conditions for the execution of construction work including its termination. The VOB/B are considered as General Terms & Conditions. Construction contracts between companies are usually governed by the VOB/B.

Both, the BGB and the VOB/B contain provisions on the termination of constructions contracts.

The Employer can terminate the construction contract at any time

The Employer can terminate a construction contract at any time until completion of the work (so called “free termination” ((Freie Kündigung))[2]. Such termination is possible regardless of whether or not the Contractor has breached any contractual obligation.

In case of a “free termination” the Contractor has no right to complete the work but he remains entitled to the agreed remuneration. However, the Contractor must deduct from its remuneration:

• any expenses saved as a result of the termination (i.e. expenses for services that no longer need to be provided), and

• any remuneration which the Contractor acquired, or maliciously refrained from acquiring, through the use of its labor elsewhere (i.e. any remuneration the Contractor gains due to the possible acceptance of new orders)

The evidence and calculations are usually difficult to provide for the Contractor. Therefore, while the Contractor remains free to calculate the specific amount, the law presumes that the contractor is entitled to 5% of the agreed remuneration for the part of the work not yet performed.

Grounds to terminate the contract

The Contractor is not entitled to its remuneration for the work not yet performed at the moment of the reception of the termination if and to the extent that the Employer had grounds to terminate the contract, in particular if the Contractor breached its (contractual) duties.

The following circumstances can, depending on the precise circumstances and the type of construction contract, constitute such grounds:

• The Contractor has not remedied a construction defect despite an Employer’s request to do so

• The Contractor acted in a way that results in the relationship of trust between the parties is no longer stable and therefore further cooperation is unacceptable (termination for “good cause”), eg. incidents of malicious deception, threats or highly aggressive behavior by the Contractor

• The Contractor has made unlawful price agreements with other companies on the occasion of the award of the contract

• The Contractor becomes insolvent

The termination has to be in writing.

In the case of termination, the work performed is invoiced according to the contract prices. However, the Employer can claim damages from the Contractor and reimbursement of replacement costs for any unfinished work.

Key considerations

As terminations become more prevalent, greater scrutiny will be placed on contractual provisions around termination and the enforcement of termination provisions. It is essential in both drafting and enforcing termination clauses that formalities and procedures are followed.

It is therefore essential that you consider the practical considerations of termination including:

1. has a replacement contractor been sourced or has the process of selecting a replacement contractor begun? Will the new contractor novate appointed sub-contractors who are familiar with the project to the employer and are there complications with doing the same?

2. are sums outstanding to contractors and sub-contractors for works done to date?

3. after termination of the contractor, what steps will be taken in respect of securing the site? Has a site audit been taken reviewing plant, equipment, and materials on site and what is the position in respect of ownership of the same? Has security been to protect the site if there is a delay in appointing a new contractor?

4. there might also be issues to be resolved with respect to insolvency law

As terminations can occur quickly, we recommend you contact us as early in the process as possible to secure the best outcome in a manner which protects your rights effectively.

[1] Sections 631 et seq, specifically in Sections 650a – 650h.

[2] see Section 648 of the German Civil Code / Section § 8(1) VOB/B)