The reform of the law on contracts for work and services, which was passed by the Bundestag and Bundesrat in March 2017 and will come into force in January 2018, will change contractual practice in the construction industry. The reform focuses on empowering builders. These are to be better secured with regard to long and complex construction projects.
Contract texts of contractors will therefore change from January 2018 and builders should also inform themselves about the innovations. Practice will then show whether a number of recurring legal issues and tricky situations can be better resolved. One thing, however, is certain: as of 01.01.2018, all construction contracts are subject to the new construction or work contract law.
Why was the law on contracts for work and services reformed?
Construction projects are long and costly. Therefore, legal certainty is important for both the builder and the contractor. The previously valid contracts for work and services and the law on contracts for work and services have now been extensively reformed. This was overdue, as the previous form of the contract for work and services dated back to the 19th century. At that time, the law on contracts for work and services had less complex work performances in mind than is the case with modern construction projects.
The previous law on contracts for work and services also made no distinction between services such as making a suit and building a house. However, it is obvious that there is a difference here in terms of complexity. The law on contracts for work and services in the German Civil Code (BGB) has therefore long since failed to do justice to everyday life in the construction industry. Thus, the reforms to this area of the Civil Code that take effect in January 2018 are also the most comprehensive to be implemented in 120 years.
What is a contract for work?
A contract for work and services is a contract under private law relating to a mutual exchange of services. The so-called customer commissions a work contractor to produce a work. The decisive difference to a service contract is that the contract not only refers to the exchange of services, but also explicitly to the performance or success – the so-called work success – of this service. Up to now, the subject of a contract for work and services could be, as it were, a car repair, shoe production, making a suit, etc., right up to the construction of a house or even highly complex projects such as the construction of an airport.
What exactly was reformed?
Of particular interest to builders and contractors is that, for the first time, a precise definition of the construction contract and a new consumer construction contract have been introduced. In addition, new regulations for architects’ and engineers’ contracts as well as property development contracts have been introduced.
So, the practice of concluding contracts with contractors and craftsmen will change from 2018. Below you will find explanations of all the changes that are important for the builder.
First definition of the construction contract by the legislator (§ 650a BGB)
In the course of the new regulations coming into force at the beginning of 2018, the legislator defines for the first time what exactly a construction contract is. Accordingly, a construction contract is a contract for the construction, restoration, removal or alteration of a structure, an outdoor facility or a part thereof.
Furthermore, contracts for the maintenance of a structure may also be considered construction contracts. Namely, when the activities specified therein are essential to the construction, existence or intended use.
The new consumer construction contract (§ 650i BGB)
At the beginning of 2018, the new consumer construction contract will come into force. It was created as a sub-form of the construction contract and is concluded between the owner and the construction company for the “construction of a new building” or “significant alterations to an existing building”. (The question of what does and does not qualify as a “significant remodeling project” will certainly be a matter for the courts).
In general, the new consumer construction contract represents a consumer protection measure by the legislature, which is intended to make contractors more accountable and give builders more claims. This is in response to the major risks posed to consumers by a construction contract.
Such risks for the builder-owner can arise, among other things, from the following: unclear contract texts, hidden clauses, insufficient information, lack of clarity about the exact subject matter of the contract, insufficient price certainty, insufficient construction and performance descriptions.
Regulations of the new consumer construction contract
1. construction description before conclusion of contract (§ 650j BGB)
As of January 1, 2018, the contractor is required to provide the owner with a detailed construction description before signing the contract. The scope of services and costs of the individual services is described in the construction description.
For the client, this results in a better possibility to compare the overall project as well as the individual services and their costs – before signing the contract! The construction description then goes into the contract. It defines the scope of services.
In addition, the construction description must include an indication of the date of completion. If an exact completion date cannot be set, at least the planned duration of the construction project must be clearly outlined.
The construction description may already be available through the work of an architect or other agent. Then the already existing construction description can be used as a basis for the contract between the owner and the contractor.
2. right of withdrawal (§ 355 BGB)
The contractor is obligated to provide the owner with a cancellation policy when the contract is signed. For this purpose, the legislator has provided model letters with which the contractor can sufficiently fulfill his obligation to instruct.
The cancellation policy states that the builder has a full 14 days after signing to cancel the contract. This gives him time to reconsider the contract and, if necessary. to be reviewed with independent experts.
It should be noted that the builder can legally revoke the contract for 1 year and 14 days if the builder has forgotten to submit the revocation notice. Even if ggfs. construction work is already underway or completed. In the case of revocation, the builder must pay for contractual services that have already been completed. In addition, he can then no longer claim any defects later, as there is also no longer a contract.
3. payments on account (§ 632a BGB)
What is a progress payment?
When building a house, the contractor makes advance payments. The constructed house is paid in principle only after completion. However, the contractor may also invoice partial services completed with the progress payments (see below) beforehand. This enables the contractor to minimize the risks he incurs through advance performance and to cover ongoing costs.
In the event of defects, the Owner shall be entitled to withhold progress payments. He must then duly report the defects.
On the other hand, the contractor is entitled to stop work on the construction of the house if the agreed progress payments have not been settled.
3.1 Amount of progress payments and securities for the contractor
As of 2018, all progress payments taken together may not exceed 90% of the total price. In addition: If the contractor is remunerated via progress payments, he may demand a maximum of 20% of the total price as security (or in the amount of the next progress payment).
Contractors do not always bill for their services via progress payments. In the case of the agreed full payment only after completion of the house, the contractor can then also demand securities in advance for 100% of the total price. Collateral for the contractor can be: Guarantee of a bank, credit insurance, security mortgages, deposit of funds or securities, guarantees by third parties.
So-called completed partial services can be:
Approval planning, floor slab (or basement), shell, roof truss, electrical and plumbing installations, kitchen (if this is included in performance), exterior installations, finishing (e.g. drywall), or even the “tight” state, which refers to the point in time when the house is tight , i.e. that the roof is covered and windows and exterior doors are installed.
3.2 Changed calculation basis of the progress payment
The progress payments will be calculated differently from 2018. They are now no longer based on the “increase in value of the client’s assets.” Such an increase in value already occurs, for example, with completed partial services – because value substance is created with the completion of individual partial services.
In contrast, progress payments are now based on the “contractual value of the services performed in accordance with the contract”. The completed partial services are therefore now calculated with respect to the contractually agreed total price. The salaries of craftsmen in particular account for a large proportion of this figure.
For example, when the shell of the building is completed, the “services rendered” usually account for 25% of the total price. This amount is then also due.
In addition, the new “services performed in accordance with the contract” clause entails that the builder may refuse to make payments if the services are not in accordance with the contract. In principle, the burden of proof lies with the contractor.
Prior to 2018, based on the “increase in value of the property,” the developer was obligated to pay for services that were not in accordance with the contract. Overall, however, the new regulation also has advantages for contractors. Because before there were often disputes about the determination of the amount, now it is easier to calculate with the “services rendered”.
4. obligation to surrender documents (§ 650n BGB)
If the contractor has carried out the planning of the construction of the house himself, he has all the planning documents (such as invoices and drawings). Prior to 2018, these documents were not mandatory to be handed over to the builder if not specified in the contract.
At least, the courts have previously held that withholding the design documents was not grounds for refusing acceptance. This changes with the new consumer construction contract. Three points are important here:
Before start of execution
Before the start of construction, planning documents must be proven to the authorities. The contractor must hand over the relevant documents. Unless the planning was done by an architect, in which case the architect has the documents.
With completion of the construction project
The contractor is obliged to hand over all planning documents at the latest upon completion of the construction project. The builder also needs these to demonstrate the legality of the construction to the authorities.
Regarding construction financing
Evidence must also be provided to lenders. This is particularly important when it comes to funding from the Kreditanstalt für Wiederaufbau (KfW). If the contractor has indicated that he will comply with the standards of the KfW subsidy, he must present the relevant documents to the building owner.
5. elimination of the distinction between significant and insignificant defects
Prior to 2018, a distinction was made between significant and insignificant defects (see below) in the refusal (and legality) of an acceptance or progress payments. This distinction is now obsolete.
What is new for builders is that it is now possible to invoke insignificant defects when refusing acceptance or payments. However, the builder must then also report these.
On the other hand, under certain circumstances, acceptance can now also come into effect in the case of significant defects (see below: acceptance fiction).
In addition, an already legally valid acceptance of the house can now no longer be challenged on the grounds of significant defects. Likewise, advance payments made now no longer have to be refunded even in the event of significant defects.
Assessment of significant and immaterial defects
What constitutes a material defect and what constitutes an immaterial defect depends on the assessment of the individual case. The assessment is based, among other things, on the cost of remedying the defect. Many insignificant defects can also add up to a significant defect.
An example in the partial roof construction:
major defect: the roof was tiled. But the roof is completely leaking because the roof waterproofing was forgotten.
insignificant defect: one place of the roof is leaking. It turns out that at this point the bricks were not laid properly.
6. fictitious acceptance (§ 640b BGB)
“Completion” instead of “ready for acceptance”.
A newly regulated aspect of fictitious acceptance clearly benefits the contractor: Prior to 2018, acceptance also had to be “ready for acceptance”. This meant that at the time of acceptance there could no longer be any significant defects.
The new term “completion of the work” introduced by the legislator now replaces the term “readiness for acceptance”.
Completion is given regardless of whether significant deficiencies remain. Thus, as of 2018, the acceptance may be valid even with material defects if the builder fails to report the defects in due time (see above: Abolition of the distinction between significant and insignificant defects).
According to the so-called fictitious acceptance, a construction project is automatically deemed to have been accepted if the client does not refuse acceptance within a period of time. This deadline is set by the contractor.
It should be noted that the contractor is obliged to notify the owner in writing of the fictitious acceptance. The automatic entry into force and the possibility of refusal of acceptance must be expressly declared in this respect. If this obligation was not fulfilled, the set deadline and also the acceptance is invalid.
If the client wishes to refuse acceptance, he must invoke a defect. As of 2018, no distinction will be made between significant and insignificant defects (see previous point above).
However, if there are significant defects and the builder does not report them to the contractor within the time limit, then the acceptance now becomes valid anyway.
The acceptance of the house and the elimination of the distinction between significant and insignificant defects
It is now quite easy for the builder to refuse acceptance of the house by citing a defect. This is because it no longer matters whether the defects are material or immaterial. An insignificant defect is practically quick to find.
On the other hand, it should be noted that the acceptance can now become legally effective even in the case of significant defects. That happens when the builder has not refused acceptance within the deadline. The deadline (including the subsequent acceptance) is only valid if (1) it was communicated in writing, (2) the consequences and the possibility of refusing the acceptance fiction were expressly explained in the written communication, and (3) it is a “reasonable deadline”.
7. termination for cause (§ 648a BGB)
The new provisions of the legislature on the reformed right of termination, which will come into force in 2018, stipulate that contractors as well as clients may terminate contracts for good cause.
Important reasons may include, but are not limited to: delay in the start of construction, defective and non-contractual performance, unannounced use of subcontractors.
Insolvency as an important reason?
The insolvency of the contractor does not automatically count as good cause. In such a case, further tests are due. This is because in many cases, work on building a house continues even if an insolvency administrator has already been involved. On the other hand, a halt to services as a result of insolvency can generally constitute good cause for termination.
7.1 Right of termination now also for “delimitable” partial services
Another change is: prior to 2018, notices of termination could only be given with respect to “completed partial services.” This regulation is now less strict with the beginning of 2018. Builders can now also make terminations legally effective with respect to “delimitable parts of the work owed.”
Examples of completed partial services: Completion of the shell, installation of all sanitary objects and piping.
Examples of delimitable partial performance: completion of the basement, installation of pipes on the first floor.
Tip: Builders should not terminate a construction contract or partial performance lightly. In any case, it is advisable to seek legal advice first.
8. cooperation of the builder-owner in the determination of the condition in case of refused acceptance (§ 650g BGB)
If the builder has reported defects and refused acceptance on the basis of this, the builder must cooperate in a determination of condition. Together with the contractor, either individual partial services or the entire house are then inspected.
There may be negative consequences for the builder if he should not cooperate in the determination of condition. This is because it is to be expected that the burden of proof will then be at the expense of the builder who is not present. It stands to reason that the deficiencies are then more likely to be interpreted as his responsibility.
Indeed, if the builder has already taken over the building, he must prove that the defects are not due to his ongoing use, but exclusively to the construction phase.
9 The new right to issue instructions (Section 650b BGB)
The new (unilateral) right to order entitles the builder to order, firstly, “changes to the agreed success of the work” and, secondly, “changes that are necessary to achieve the agreed success of the work” after setting a deadline.
Example of “Changes to the agreed work result”: The floor on the first floor is now to be covered with tiles instead of parquet.
Example of “changes required to achieve the agreed success of the work”: If something was forgotten during planning but is necessary for the successful completion of the planned construction of the house, e.g. forgotten ventilation flaps, etc., then the changes must be made in writing.
The Contractor must respond within 30 days of receipt of the change request. Efforts must be made to reach an agreement. If there is still no agreement, the builder can order the changes. It should be noted that the changes must be “reasonable services.”
9.1 Subsequent costs Right of order (Section 650c (1))
For all change requests submitted, the Contractor must submit a quote for the cost of the change sought within the 30-day period.
If the owner and contractor do not agree on the costs within the time limit, the owner may still order the changes (unilateral order). However, this can be expensive for him. Because without prior agreement, the contractor can set the price itself.
In addition, the contractor can then charge 80% of his own asking price for the cost of the changes with the following progress payment.
In the case of the order the owner must count therefore on high costs, which come already with the lining up partial payment on him.
This represents a clear advantage for the contractor and an indirect weakening of the new right to order. This is because it creates financial risks for the builder when he uses his new right of unilateral order: The costs incurred in the process are determined solely by the building contractor.
In this context, it is important for the builder-owner to bear in mind: If the costs were set at an above-average level, the builder can demand repayment including interest.
Nevertheless, there are still risks for the building owner: In the event of the contractor’s insolvency, this money would be lost for the time being.
If, on the other hand, additional costs are incurred for “changes that are necessary to achieve the agreed success of the work”, these will, in principle, have to be borne by the party that was responsible for the inadequate planning of the project.
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