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 PLC multi-jurisdictional guide to outsourcing. For a full list of contents, please visit www.practicallaw.com/outsourcing-mjg.
National law does not specifically regulate outsourcing transactions. This presents challenges in drafting and concluding agreements that satisfy both parties' requirements. Outsourcing agreements are mixed-type agreements, which can include various different contract types regulated by the German Civil Code (Bürgerliches Gesetzbuch (BGB)), for example:
Sales contracts.
Services contracts.
Leases (see Question 8).
Works contracts (see Question 26).
Contracts regulating the transfer of assets or shares (see Question 5, Asset or share deal).
The BGB's provisions apply to outsourcing agreements.
The outsourcing of financial services is subject to a strict regulatory regime that considers clients' and investors' interests, as well as the stability of the overall financial system.
The applicable law depends on the nature of the financial services company, as well as the operational activities to be outsourced (see below). Personal information and other highly sensitive individual data are protected by the:
German Federal Data Protection Act (Bundesdatenschutzgesetz (BDSG)).
Respective state statutes.
Principle of banking secrecy (which the supplier must be contractually required to follow).
In relation to data protection, see Question 18.
Outsourcing by credit and financial services institutions. Credit and financial services institutions include, among others:
Investment advisers.
Investment and contract brokers.
Portfolio managers.
Custodian banks.
The outsourcing of operational areas that are essential for conducting banking business or providing financial services to third parties is:
Subject to regulatory law.
Supervised by the German Federal Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)).
The outsourcing must not impair (section 25a, Banking Act (Kreditwesengesetz (KWG))):
The customer's proper organisation of business and services.
The customer's ability to properly and effectively manage risks, including the outsourced services.
BaFin's right to audit and ability to monitor the business or services.
BaFin issued Circular 11/2010 (BA) on 15 December 2010 (revised Circular) for Minimum Requirements for Risk Management (Mindestanforderungen an das Risikomanagement). This includes requirements for banks and financial services institutions that outsource, and supersedes Circular 15/2009 of 14 August 2009. The revised Circular ensures compliance with:
The guidelines on outsourcing issued by the Committee of European Banking Supervisors.
Directive 2004/39/EC on markets in financial instruments and Articles 22 and 123 of Directive 2006/48/EC relating to the taking up and pursuit of the business of credit institutions.
The revised Circular provides detailed guidance on outsourcing requirements, including:
Core management functions (Leitungsaufgaben der Geschäftsleitung) cannot be outsourced. This includes activities that are legally assigned to management (for example, strategy formation and the selection of executive officers).
The customer remains responsible for compliance with all regulatory requirements and cannot delegate these to the supplier.
The customer must include any outsourced activities in its risk management process and provide for proper supervision. If the internal auditing is outsourced, the customer must appoint an auditing officer.
The customer must provide proper measures in termination of the outsourcing contract to ensure continuity and quality.
Contracts for outsourcing of essential areas (which the customer self-assesses on the basis of a risk analysis) must include:
the specification of the services provided by the supplier;
the specification of the customer's information and auditing rights;
safeguarding BaFin's information, control and auditing rights;
the customer's right to give instructions unless the services are clearly specified in the outsourcing agreement;
compliance with data protection requirements (see Question 18);
proper termination rights;
a clause insisting that any subcontracting will follow all the Circular's requirements for outsourcing;
the supplier's information obligations.
Circular 6/2010 (WA) of 2 July 2010 on the tasks and obligations of the custodian bank in the meaning of sections 20 et seq. of the German Investment Act (Investmentgesetz (InvG)) includes requirements for custodian banks.
Outsourcing by investment services companies. Investment services companies (Wertpapierhandelsunternehmen), such as brokers and investment traders, are subject to section 33(2) of the Securities Trading Act (Wertpapierhandelsgesetz (WpHG)). Its requirements refer to and supplement those of section 25a of the KWG (see above, Outsourcing by credit and financial services institutions). Under the revised Circular, the outsourcing of portfolio administration for private clients to a company located abroad requires that the service company is validly and sufficiently authorised to carry out these services or if such outsourcing was notified with BaFin, that BaFin did not reject the outsourcing within a reasonable period of time (section 33(3), WpHG). BaFin further specified in its Circular 4/2010 (WA) (as at 14 June 2011) the minimum requirements for the compliance function and additional rules of conduct, organisational and transparency obligations applicable to investment services companies under section 31 et seq. of the Securities Trading Act (Mindestanforderungen an die Compliance-Funktion und die weiteren Verhaltens-, Organisations- und Transparenzpflichten nach §§ 31 ff. WpHG für Wertpapierdienstleistungsunternehmen (MaComp)). The Circular merges all of BaFin's relevant previous circulars and notices. Under the Circular, it is recognised that the compliance function can be outsourced subject to the conditions of section 25a(2) of the KWG, in connection with section 33(2) of the WpHG.
Outsourcing by capital investment companies. Capital investment companies (Kapitalanlagegesellschaften) can outsource their business activities if outsourcing does not hinder the company from acting in the investors' and clients' interests.
This outsourcing is subject to:
Section 16 of the InvG.
The capital investment company's rules on the distribution of investments (which are set on a regular basis).
The capital investment company:
Remains liable for any of the supplier's faults.
Must list the outsourced tasks in the sales prospectus, which it must publish in accordance with section 42 of the InvG.
If the transfer concerns portfolio management, only companies licensed for asset management and under public supervision can carry out the business. BaFin issued Circular 5/2010 (WA) on 30 June 2010 for minimum requirements for risk management for capital investment companies (Mindestanforderungen an das Risikomanagement für Investmentgesellschaft), also based on the fact that capital investment companies no longer qualify as credit institutions under the KWG. The revised Circular provides detailed guidance on outsourcing requirements, including for example:
Based on a risk analysis, the capital investment company is responsible for carefully deciding which areas can be outsourced.
Core management functions (Leitungsaufgaben der Geschäftsleitung) cannot be outsourced.
Regarding the management of real estate portfolios, the final decision on the acquisition and sale must remain with the capital investment company.
Precautionary measures must be taken to ensure that when the outsourcing expires, the outsourced task can continue with the same quality of service.
Certain specified requirements must be met for outsourcing agreements.
The capital investment company must properly control the outsourcing, which includes the identification, evaluation and controlling of risks, and supervision of the outsourced tasks.
Outsourcing to the custodian bank (Depotbank) may only be possible if certain requirements are met.
The external auditors may need to be instructed to render auditing tasks at the supplier.
With regard to any sub-outsourcing, the same requirements as to the primary outsourcing itself must be met.
Outsourcings in areas such as human resources and facility support are subject to:
The BGB's general provisions.
Employment laws.
Data protection laws.
Other relevant statutes.
There are no additional regulations relevant to IT outsourcing. It is recommended that the supplier complies with the ISO 27000 series of norms for IT security.
The supplier must observe the secrecy of telecommunications rules set out in section 88(2) of the Telecommunications Act (Telekommunikationsgesetz (TKG)). In addition, the TKG's specific data protection provisions may replace the more general provisions of the BDSG, such as, for example, section 91 of the TKG.
If a public sector outsourcing's transaction value exceeds certain financial thresholds, it must be carried out through an official tender process regulated by the Act against Restraint of Competition (Gesetz gegen Wettbewerbsbeschränkung (GWB)).
In addition, the following may need to be observed:
The Tender Procedure (Vergabeordnung).
The Contracting Rules for Awards of Public Service (Verdingungsordnung für freiberufliche Leistungen (VOF)), of Public Works (Vergabe und Vertragsordnung für Bauleistungen (VOB)) and of Delivery (Verdingungsordnung für Leistungen (VOL)).
Public procurement above certain financial thresholds is also regulated by:
Directive 2004/17/EC co-ordinating the procurement procedures of entities operating in the water, energy, transport and postal services sectors (Utilities Directive).
Directive 2004/18/EC on the co-ordination of procedures for awarding public works, supply and service contracts (Consolidated Public Sector Directive).
These Directives promote equal treatment between suppliers and set up a transparent awards procedure.
For insurance companies, Circular 3/2009 (VA) sets out minimum requirements for risk management in outsourcing transactions. The Circular details the regulations of section 64a and section 104s of the Insurance Supervision Act (Versicherungsaufsichtsgesetz (VAG)) in conjunction with Article 9 of Directive 2002/87/EC on the supplementary supervision of credit institutions (Financial Conglomerates Directive) and provides a framework for risk management of the undertakings, groups and financial conglomerates under supervision. Principally, any outsourcing of services, irrespective of its materiality, needs to comply with the regulatory requirements. It is expected that the review of Directive 2009/138/EC on the taking-up and pursuit of the business of insurance and reinsurance (Solvency II Directive) will simplify the outsourcing of non-material services.
The outsourcing of electronic bookkeeping outside Germany within the EU and the European Economic Area (EEA) can be permitted by the Revenue Service (section 146(2a), Revenue Code (Abgabenordnung) (AO)), and outside the EEA only if taxation is not impaired.
The customer must always carry out due diligence of the supplier to ascertain whether the supplier can deliver the proposed services. If outsourcing constitutes data processing on assignment, a written agreement must be in place satisfying the requirements of section 11 of the BDSG (see Question 18). The customer must be certain that the supplier complies with its data protection obligations, and it must also foresee audit rights in the written contract.
Outsourcing of portfolio administration for private clients by investment services companies to a supplier abroad requires that the supplier has valid and sufficient authorisation to carry out these services. Alternatively, the outsourcing can be notified to BaFin who can reject the project within a reasonable period of time (see table, Regulatory notification and approval of outsourcing transactions). Investment services companies that have several entities competing with each other must be wary of their infrastructure and maintain a strict separation between the competing entities, both from an IT perspective and regarding location. Capital investment companies can outsource the portfolio administration only to suppliers that are licensed for administering portfolios and which are subject to effective public supervision. If tasks are outsourced to the custodian bank, sufficient organisational requirements and an escalation procedure must be agreed. However, neither the custodian bank nor any other supplier having a conflict of interests with the capital investment company or investors may be entrusted with the portfolio administration.
Transfer of various assets requires registration of the transfer. Change in ownership of patents must be registered with the Patents and Trade Mark Register. Transfer of real estate requires notarisation and must be entered into the land register.
Outsourcing of portfolio management by investment services companies for private customers to suppliers outside the EU or EEA must either be (section 33(3) WpHG):
Notified to, and not rejected by, BaFin.
Have a supplier that is properly authorised for the services.
Where notice to BaFin is required, it must be given before the outsourcing. Approval is not necessary, and BaFin generally has three months in which to consider and potentially reject the planned outsourcing. There is no form for the notice. BaFin will not object to the outsourcing if it fulfils certain BaFin conditions. Supervision by the foreign supervisory authority must be valid and similar to that of BaFin over asset managers within its authority. This requires that both the:
Permission for asset management is linked to certain conditions similar to those in Germany.
Foreign supervisory authority has proper authorisation to review existence of the requirements for permission for asset management on a continuous basis.
The law does not specify further requirements.
Capital investment companies must notify the BaFin of all existing outsourcing arrangements during a business year at the end of such business year (section 16(3) InvG). If direct insurance companies outsource certain essential areas (functional outsourcing), the effectiveness of any such agreements is subject to notification to BaFin and approval or expiry of a waiting period.
An outsourcing transaction may fall under German merger regulations if it is considered a merger under section 37 of the Act Against Retraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen (GWB)). A German merger control may apply if:
The worldwide turnover of the supplier and the customer exceeds EUR500 million (as at 1 February 2012, US$1 was about EUR0.8).
One party exceeds a turnover of EUR25 million in Germany and the other party exceeds a turnover of EUR5 million in Germany.
If the merger filing requirements are given, the outsourcing transaction must be notified to the cartel office. The cartel office can prohibit the transaction if it notifies the parties within one month of notification that it will open a main proceeding regarding the merger (§40 GWB).
Outsourcing deals are usually structured as direct outsourcing or indirect outsourcing.
Direct outsourcing involves a contract between the customer and the supplier.
The advantages of direct outsourcing include that:
Additional joint venture (JV) or partnership agreements are unnecessary.
In termination of the contract, there is no need to dissolve entities or partnerships.
There are clear objectives (that is, for the customer to gain service quality, and for the supplier to make a profit).
The disadvantages of direct outsourcing include:
Loss of know-how.
Loss of control.
No vehicle to provide services for third parties.
In indirect outsourcing, there is no direct outsourcing contract between the customer and supplier.
The advantages of indirect outsourcing include the:
Opportunity for both parties to make use of their respective know-how.
Opportunity to gradually transfer the service into a JV or other vehicle.
Use of a vehicle to provide services to third parties.
Provision for control on a shareholder level.
The disadvantages are that the resulting level of management and risk-sharing can reduce some of the potential cost savings and delay a timely integration process. In addition, in an exit scenario, the JV must be dissolved in addition to terminating the outsourcing agreement.
In international outsourcings, parent companies typically enter into a framework agreement, and the subsidiaries in the respective countries provide the international services. The subsidiaries can also become parties to the outsourcing agreement or enter into separate contracts under the framework outsourcing agreement. In these cases, certain guarantees by the parent company should be considered.
Indirect outsourcings can comprise a JV between the customer and the supplier, together with an outsourcing agreement between the customer and the JV (see below, JV or partnership).
Description of structure. The customer and supplier set up a JV for the outsourcing, or run an outsourced division in the form of a JV. Suppliers can also form a JV or partnership between them. Parties typically choose to create a JV if material assets or confidential information are to be transferred.
Advantages and disadvantages. The advantages and disadvantages are the same as for indirect outsourcings (see above, Indirect outsourcing). Responsibilities and liabilities must be clearly defined.
Description of structure. In a strategic outsourcing, the customer has already transferred certain services into a separate business division within its group. As the next step, the customer outsources the division to the supplier. It can be transferred to the supplier through either:
An asset or share deal (see below, Asset or share deal).
A JV between the customer and the supplier. Generally, after a period of three to seven years, the customer transfers its remaining shares in the JV to the supplier (see above, JV or partnership).
The supplier runs the division separately or integrates it into its business group.
Advantages and disadvantages. The advantage of a JV is that the customer still has some control over the outsourced business division including its know-how. The disadvantage may be a limited cost reduction.
Description of structure. Certain divisions within a company are internally outsourced to establish specific centres of competence or shared service centres. The internally outsourced centres can enter into consultancy agreements with outsourcing companies.
Advantages and disadvantages. The advantages of using the captive entity structure are the:
Pooling of know-how within the company.
Reduction of redundancies.
The disadvantages of using this model are that:
Any cost reduction can be limited.
Specialist know-how from outsourcing providers cannot be used.
Description of structure. The assets in an outsourcing can be transferred through an asset or share deal:
Asset deal. Typically, in an asset deal, tangible items are physically handed over under section 929 of the BGB and intangible items are transferred through assignment under section 398 of the BGB. Each individual asset must be clearly specified to transfer validly.
Share deal. The customer assigns the shares in the outsourced company to the supplier. The individual assets automatically transfer to the new owner without the requirement to list each item.
Advantages and disadvantages. The advantage of an asset deal is that the customer can choose to keep certain assets. The disadvantage is that in order for a valid transfer, each single IT component including hard- and software as well as the existing agreements need to be specified. The advantage in a share deal is that all assets will be transferred to the supplier without the requirement of listing those assets. The disadvantage is that in a share deal there is always the situation of a transfer of employees by operation of law (see Question 9).
For tax liabilities on asset deal or share deal, see Question 37, Transfers of assets to the supplier.
The process of selecting a supplier usually begins with establishing an interdisciplinary in-house project team from the relevant business areas affected by the outsourcing project.
The customer may then decide to either:
Start a tender process (with or without a request for proposal) for its outsourcing services.
Approach one or more potential suppliers directly.
The most appropriate procurement procedure depends on the:
Services to be outsourced.
Sophistication of the marketplace.
Business objectives of the customer.
Outsourcing structure that the customer chooses (see Question 5).
The tender process can give the customer more favourable terms and conditions because of competition between the potential suppliers. It can also give the customer a broader choice of possible services. However, it can be very time-consuming because of multi-party negotiations. Therefore, the customer usually restricts the tender process to three or four bidders.
An RFP describes the project, its scope, the services and service levels that the customer expects to be provided. It should specifically ask how the bidder can fulfil these requirements. In addition, it can ask for references in relation to the bidder's experience in outsourcing, as well as an invitation to provide an offer. When the customer receives the responses, it must evaluate them against its own evaluation criteria.
An invitation to tender briefly outlines the outsourcing project and invites suppliers to provide an indicative offer, including documentation of the supplier's abilities and financial viability. The customer then prepares a shortlist of suppliers, based on their:
Abilities.
Cultural fit (that is, the suitability of, for example, their management style, team and customer orientation, political style, and attitudes).
Price.
Experience in relation to the services in question.
As part of an internal due diligence, the customer must clearly define the:
Outsourcing's requirements.
Outsourcing's scope.
Outsourcing's services and service levels.
Supplier's financial standing.
In addition, the customer should carry out economic and technical due diligence of the supplier to ensure expected quality standards are met.
The supplier should carry out due diligence of all assets, contracts, facilities, rights, business divisions and so on that it will acquire. Based on the outcome of due diligence, the supplier further examines whether:
It can provide the services at a price that the customer is willing to pay.
The outsourcing can give the supplier a margin for its business, including any economies of scale.
Negotiations can be conducted with one or more bidders. At a more advanced stage, the bidder can ask for an exclusive negotiation period to avoid lengthy negotiations that may not result in agreement.
Usually the parties enter into a non-disclosure agreement before negotiations (confidentiality agreement). Special consideration must be given to non-disclosure provisions in contracts with third parties.
Any agreement to transfer immovable property requires notarisation. If another agreement, such as an outsourcing contract or a lease, is linked to the property purchase agreement so that the contracts are interdependent, the other agreement must also be notarised to ensure validity of both agreements.
For the transfer of immovable property, both of the following are required:
An agreement on the transfer of the right in rem to the acquirer (section 925, BGB).
Registration of the change of the property's legal position in the land register.
To minimise the potential risks of delays in the registration process, a priority notice should be entered into the land register. The parties may have to obtain authorisations required by public law, such as the municipal pre-emption right under section 24 of the Building Law Act (Baugesetzbuch (BauGB)).
If immovable property is to be transferred back to the customer (insourced) after termination of the outsourcing agreement, the agreement should include a pre-emption right or priority notice of conveyance, and the relevant entry into the land register should be made.
A copyright owner cannot transfer authorship to another party, but can transfer certain rights attached to this authorship. The transferor must be entitled to transfer IP rights to the service company. If the transferor is not the copyright owner (such as in the case of leased or used software), the transferor requires the copyright owner's consent.
The parties must describe the IP rights in detail to transfer them. The transfer of certain IP rights should be recorded in the relevant registry, as only the registered owner of IP rights can bring proceedings before the Patent and Trademark Office (Deutsches Patent- und Markenamt) and the courts.
Licences are not registered in Germany and no formal filings with the registration offices are necessary on transfer. The outsourcing contract should specifically describe the licence and the parties should ensure the customer is entitled under its licence to transfer or sub-license the right to the supplier.
If the supplier is located outside Germany, licenses and IP rights necessary for the functions carried out by the supplier must be valid and not conflict with third party rights in the supplier's country of residence.
The owner must physically transfer possession of the property and the parties must agree to transfer it.
Agreements that relate to the transfer of movable property do not require formalities. However, for reasons of clarity and evidence, they should be concluded in written form.
An agreement concerning the transfer of movable property must be notarised if all or part of the customer's current assets are transferred to the supplier. If the property is transferred to a supplier outside Germany, customs regulations must be complied with. Depending on the country of the supplier certain assets may not be easily transferable (see below, Offshoring).
The BGB only regulates the transfer of single claims and liabilities, and not the transfer of an entire contract. However, contracts can be transferred with the consent of all three parties (customer, supplier and the third party). This can be obtained through either a:
Tripartite agreement.
Two-party contract between the customer and the supplier with the consent of the third party (which can be given in advance).
The contract for the transfer of the key contract must follow the same formalities as the key contract itself, imposed by legal provisions or by the agreement itself. The key contract may have to be adapted to mandatory local law requirements if the supplier is outside Germany.
If services are provided in Germany for a customer outside the EU, certain restrictions may apply according to the Export Law Act (Außenwirtschaftsgesetz) and to the Export Law Regulation (Außenwirtschaftsverordnung) if it concerns military related material or goods that are of strategic importance, such as technology for air traffic control or radar equipment. The same restrictions may apply in the opposite direction.
If the offshoring entails the transfer of personal data to the supplier, the supplier must provide an adequate level of protection by either:
Complying with the Safe Harbour Framework programme in force between the US and the EEA.
Entering into model clauses approved by the European Commission with the customer.
Implementing binding corporate rules.
Leases must be concluded in written form if the lease term exceeds one year.
If the customer is the property tenant, it can also sublease the property to the supplier with the landlord's consent, which can be given in advance or on request, and can generally only be withheld for good reasons.
See Question 7, IP rights and licences.
There are no formality requirements for leases that relate to movable property, but for reasons of clarity and evidence, they should be concluded in written form.
There are no formality requirements for leases that relate to movable property, but for reasons of clarity and evidence, they should be concluded in written form.
Protective legislation for employees plays a major role in outsourcing transactions.
The key legal protection for transferred employees is provided for under section 613a of the BGB, and is largely based on Directive 2001/23/EC on safeguarding employees' rights on transfers of undertakings, businesses or parts of businesses (Transfer of Undertakings Directive). Where the whole or part of a business is transferred to a third party by contract, the employees' contracts with the transferor transfer to the transferee by operation of law. Managing directors or members of the management board are not transferred, as they are not considered employees under section 613a of the BGB.
The business is transferred if it is a long-term economic unit, which despite the transfer, retains its identity. The courts consider all facts to determine whether this is the case. The assessment is usually based on the following criteria:
The type of business or company involved.
Whether tangible and intangible assets are transferred.
Whether key employees are transferred.
Whether clients are transferred.
Any similarity of activities before and after the transfer.
The duration of any interruption of activity.
The functionality of the business after the transfer and the capability of transferee to carry out the same or similar activities.
According to the latest Federal Labour Court judgments, in numerous outsourcing transactions the determining factor is whether the incoming supplier takes over any tangible or intangible assets and/or whether the supplier takes over a significant number of employees.
If a change of supplier constitutes a business transfer (see above, Initial outsourcing), the new supplier takes on all the employment relationships that existed with the old supplier as part of this business. To avoid the transfer of employees, the new supplier must carefully review the old supplier's activities and ideally, not use any of the old supplier's assets or employees.
If services are insourced again, and this constitutes a business transfer (see above, Initial outsourcing), the customer takes on all the employment relationships that existed with the supplier as part of this business.
On a business transfer, the transferee succeeds to the rights and duties arising from the employment relationships as if it were the transferor. "Employment relationships" within this meaning covers:
All employees that are assigned to the transferred part of business, regardless of whether they are blue- or white-collar workers.
Executives or apprentices.
Employees with fixed-term or suspended employments.
Temporary agency workers are transferred only if the lender itself is the transferor. Contracts of board members, self-employed workers and civil servants are not included in the transfer.
Section 613a of the BGB is mandatory, so a customer cannot retain employees of the transferred business by contractual means. However, the customer can try to retain a single employee by contractually assigning him to a business that is not transferred.
An employment relationship cannot be terminated by the customer due to the transfer of a business.
The transferee takes on all pension rights and obligations of the business's active employees. Pensioners and former personnel of the transferred business are not active employees and therefore do not have their pension rights passed on to the transferee.
The transferee takes on all contractual benefits of the employees of the transferred business, even if these benefits are not explicitly stated in the employment agreement. This also applies to share option plans offered by a German employer, unless the rights are derived from share option plans with a German or foreign parent company.
On a business transfer, collective bargaining agreements (CBAs) and shop agreements that were in force at the time of the transfer of the business either:
Remain in force on a collective basis provided that either:
in relation to CBAs, the transferee is a member of the same employer's association as the transferor;
in relation to shop agreements, the transferred business operation retains its identity.
Are transformed into individual contractual provisions for each employee and have the same legal character as provisions in an employment agreement.
The employer cannot modify the transferred employees' CBA or shop agreement to their detriment until one year after the transfer of the business.
If the transferee already has a CBA or a shop agreement with similar provisions in force, the transferee can replace the transferred employees' CBA or shop agreements with its existing one if the transferred employees fall within the scope of its existing CBA or shop agreements.
Employers are in general not obliged by law to make a redundancy payment if an employee is dismissed through redundancy. However, as each employee is free to file an action against the dismissal, it is common practice that an employer (before or during a lawsuit initiated by the employee) offers the employee redundancy payment. The redundancy payment generally amounts to one-half of a monthly salary per each year of employment. This can vary depending on the likelihood of success of the employee's non-dismissal claim.
The transferee can modify the transferred employees' employment agreements to the same extent to which the transferor was able. In particular, the transferee can do this through:
An amendment agreement.
Dismissal with the option of altered employment conditions.
On a business transfer, any modification of an employment agreement that is substantially to the employee's detriment is subject to justification on objective grounds. For the modification of CBAs or shop agreements on a business transfer, see Question 10, Other matters.
A dismissal is invalid if it is based on the transfer of a business or part of a business (that is, if the transfer of the business is the reason for the dismissal) (section 613a (4), BGB). Dismissals on other grounds (for example, relating to the employee's conduct or for operational reasons) remain permissible.
If an employee objects to the transfer of his employment agreement to the transferee, and the transferor cannot retain him for business reasons, then the employee, under certain circumstances, can be dismissed for operational reasons.
In the private sector, the outsourcing of services is unrestricted. There are only a few "official" positions, such as a radiation protection officer, that must be filled by a company's own employees and therefore cannot be outsourced.
If the outsourcing is considered as a transfer of business according to section 613a of the BGB, such provisions are mandatory and cannot be waived or circumvented by other contractual arrangements.
The transferor and transferee have no legal obligation to provide information to each other in relation to employees. Therefore, it is advisable for the parties to acquire this information during due diligence and to implement appropriate clauses in the underlying contracts.
Either the transferor or the transferee must inform each employee in writing before the transfer of the business (not necessarily before the signing of an outsourcing agreement) regarding the:
Date or planned date of the transfer.
Reasons for the transfer of the employees.
Legal, economic and social consequences of the transfer for the employees.
Intended measures to be taken in relation to the employees (for example, certain training measures, a reconciliation of interests (Interessensausgleich) or social plan (Sozialplan)).
The employee is entitled to object to a transfer of his employment agreement within one month after he has been fully informed about the transfer. If the transferor or the transferee provides incomplete or false information, the employee has an unlimited right to object to the transfer. If the employer provides the employee with a "new" or additional information letter, the receipt of this information letter triggers a new one-month time limit for the employee to object to the transfer. It is advisable to agree in an outsourcing agreement whether the transferor or transferee is liable for the correctness and completeness of the information given to employees.
As an employee has the right to object to the transfer of his employment agreement to the transferee within one month after the receipt of the information letter, the employees should be informed at least one month before the transfer of business to provide clarification to all parties concerned before the implementation of the transfer of business. If an employee objects to the transfer of his employment agreement, his employment relationship remains with the transferor. The employee runs the risk that the transferor will terminate the employment agreement for business reasons (see Question 13).
If a business is transferred as a whole, a works council, if in place with the transferor, has no co-determination rights. If a business is split up or substantially reduced, or if its internal organisation has changed, this can be considered as an operational change under section 111 of the Works Constitution Act (Betriebsverfassungsgesetz (BetrVG)), with the consequence that the transferee must inform and consult the relevant works council before the transfer of the business. The works council must be informed before the execution and implementation of an outsourcing agreement, and significantly before the information letter is handed out to the employees. The purpose of the works council information requirement is to start discussions and negotiations between management and the works council. The negotiations end in a written plan on the details of the proposed outsourcing measures (reconciliation of interests), which describes:
The operational changes to be made.
The schedule of changes.
How employees will be affected.
A failure to inform and consult can lead to compensation claims by the employees for disadvantages suffered.
In addition, the works council can request a social plan if a substantial number of employees are affected by the changes. A social plan is an agreement between the management and the works council that regulates benefits to the respective employees, to provide full or partial compensation for any financial detriment, particularly resulting from unemployment. The most commonly disputed issue is redundancy payments. This procedure can take up to a few weeks or even months.
General requirements. Generally, only personal data is subject to enhanced protection under the law. Personal data is defined as individual information on the personal or factual relations of an identified or identifiable natural person.
The BDSG regulates any collection, processing and use of personal data (data processing). Area-specific legislation may apply to personal data in the telecommunications and media, health, banking and finance sectors (see Question 2).
Generally, data controllers and processors must:
Comply with the requirements for data processing.
Provide for technical data security measures and protection from loss of data.
Oblige its employees to obey data secrecy rules.
Appoint a data protection officer.
Data processing within the EEA requires either statutory permission or express consent by the data subject.
Data can only be transferred outside the EEA if the data subject has no outweighing interest in being protected. A person usually has such interest in being protected if the recipient's standard of data protection is lower than the EU standard. In this case, the consent of the person concerned must be obtained, unless a statutory exception applies. The EU standard can be achieved, for example, if the recipient of the data either:
Joins the safe harbour (for the US).
Has entered into the EU model contract with the customer.
Has implemented binding corporate rules.
Mechanisms to ensure compliance. The outsourcing contract must provide for audit and control rights of the customer, and reporting duties for any data protection issues or breaches.
International standards. For data security, the supplier should have IT security policies governing the handling of IT systems and the information within them. The customer should ask to review these to the extent that they are not confidential. Suppliers can also certify under ISO/IEC 27000 series, which provides best practice recommendations on information security.
General requirements. The supplier must be contractually obliged to comply with the principle of banking secrecy.
Mechanisms to ensure compliance. Audit rights and notification duties for breaches must be in the contract.
International standards. The supplier should comply with the ISO 27000 set of norms.
General requirements. Data transferred to the supplier should be marked confidential and protected by respective contractual safeguards if the customer deems this necessary. If the customer data contains trade secrets, the supplier should be alerted to this fact. Trade secrets are protected under the Act against Unfair Competition (Gesetz gegen den unlauteren Wettbewerb (UWG)).
Mechanisms to ensure compliance. Audit rights and notification duties in case of breaches need to be stipulated in the contract. Trade secrets need to be marked as such and as confidential.
International standards. The supplier should comply with the ISO 27000 set of norms.
During an outsourcing project, a data transfer can occur in two different ways, as either:
Data processing on assignment (Auftragsdatenverarbeitung) (that is, the customer outsources data processing). In this case, the supplier is strictly bound by the customer's instructions and is not itself responsible under most of the regulations. The customer remains liable for most of the obligations under the BDSG. This only applies to outsourcing scenarios in the EEA. If the recipient is outside the EEA, the supplier will always be considered to be a third party.
A by-product of the outsourcing of a function. In this case, both the customer and the supplier must comply with the regulations because the supplier is considered to be a third party. Therefore, transfer to and from the supplier is a relevant data transfer, which is subject to the regulations.
Data processing on assignment requires a written contract. This contract must regulate (section 11, BDSG):
Subject and duration of the assignment.
Scope, manner and purpose of the contemplated collection, processing and use of personal data, the kind of data and the data subjects.
The technical and organisational security measures to be undertaken.
Rectification, deletion and blocking of data.
Duties of the supplier, including control duties.
Right to sub-outsourcing, if any.
Control rights of the customer.
Potential violations by the supplier that must be notified to the customer.
The scope of authority the customer retains towards the supplier.
Return of data carriers and deletion of data stored by the supplier.
The customer must be assured of the security measures undertaken by the supplier before beginning data processing. Violation of these requirements can result in a fine of up to EUR50,000.
If the outsourcing project constitutes data processing on assignment, the above requirements must be complied with. If it does not, the supplier will be a data controller itself and thereby fully responsible under German data protection law. However, the customer will want to see appropriate safeguards for its data in place, most likely similar to the requirements outlined above, to protect its data.
The services specification is a crucial element of the outsourcing transaction and must be carefully drawn up. Both parties usually contribute to it. The customer is generally better equipped to decide what services it must receive and how those services can be adapted during the outsourcing contract's term. It must ensure that it receives the services at a certain level of quality and on an agreed cost basis. The supplier must specify what service levels it can provide based on its previous experience. The services specification is the benchmark for the calculation of the services to be provided and the fees.
Therefore, the outsourcing agreement typically provides for a:
Detailed description of the services in question.
Clear division of the parties' responsibilities in relation to those services.
Service levels set out the specific performance and services that the supplier must provide to the customer. Without any agreed service levels, the supplier must provide services of an average quality (section 243, BGB). However, this is usually insufficient for outsourcing purposes.
The service levels are generally included either as part of the main outsourcing agreement or in annexes to the agreement. Service levels also divide responsibilities between the parties and are the basis for key performance indicators, contractual penalties, damage claims and termination rights (see Question 25). They often include:
Escalation procedures.
Re-negotiation provisions.
Reaction times.
Penalties.
Availability.
Standard change requests.
A set procedure for non-performance.
Service levels must be drafted clearly, as the parties can only judge the outsourcing transaction's financial impact if they know the services to be provided. At the same time, service levels should be flexible to deal with changes over time and be modifiable by customer demands.
Service level credits give the customer the right to lower fees where the supplier does not perform within agreed service levels. Usually, certain percentages are deducted from the fees owed, depending on the level of non-performance. Where service level agreements are considered to be standard terms and conditions (section 305, BGB), the value of the deduction cannot be higher than the customer's typical expected damages.
This is suitable if the supplier must build a specific product, or if the scope and volume of the service can be pre-determined, and the customer wants certainty for budgeting purposes.
Flexible prices are usually based on actual accrued time, or other units.
Fixed- and flexible-price models are regularly combined according to the nature of the service. Typically, a fixed price is chosen to provide the basic service, and additional services are charged on a flexible basis.
Cost plus is the payment of the actual costs incurred, plus an additional agreed profit margin for the supplier. The parties must include mechanisms for cost determination and review, such as benchmarking and automatic adjustments.
The supplier is rewarded according to its performance. If less than the agreed performance level is reached, the supplier is paid less. If performance exceeds the agreed specifications, a bonus is paid.
Pay as you go can be partially implemented with cloud computing outsourcing projects. While the basic service would be provided on a fixed rate, additional services and storage space can be added to the services, and deleted again, and are only paid on request and as needed by the customer.
The parties must decide whether:
The supplier can recover its implementation costs at the start of the outsourcing. If so, payment is generally subject to certain conditions. The parties should agree on a partial initial payment, with further payments depending on clearly defined and determinable progress.
To spread the costs over the life of the outsourcing agreement. If so, the parties should include a clear provision stating which party bears the remaining unpaid implementation costs if one party terminates the agreement.
Adjustment provisions must comply with section 1 of the Price Clause Act (Preisklauselgesetz). Under these rules, automatic adjustment clauses based on the price or value of other goods or services are not permissible. This prohibition does not apply to clauses:
That permit discretion in the determination of the adjustment.
In which the rated goods are materially similar or at least comparable.
In which the owed amount is made directly dependent of the development of goods or services to the extent these directly influence the prices of the creditor.
That can only reduce the price.
Further exceptions may apply to certain long-term contracts (at least ten years) unless the adjustment clause puts one party at an unreasonable disadvantage.
For benchmarking, see Question 24, Benchmarking.
Implied warranties apply to faulty or non-performance of essential obligations. A claimant has the right to:
Demand performance and/or damages.
Demand supplementary performance.
Rescind the contract.
Terminate the contract.
Because of the contract's nature as a continuing obligation and the expectations of trust from both parties, the right to rescind is usually replaced by a right to extraordinarily terminate the contract, if a reason for termination exists.
Where there is termination for non-performance of one element of the outsourcing agreement, the validity of the rest of the contract depends on whether the various obligations were meant to be interdependent, as understood in accordance with the parties' intentions. The exact nature and requirements of these rights depend on the classification of the individual contract provision.
The project is structured to deal with open issues or disagreements during the outsourcing term. The project management team controls the outsourcing's operative level, and in addition, the parties usually implement a steering board to deal with issues that are unresolved by the project management.
Change request clauses (that is, provisions that enable a party to request changes to services or service levels from the other party) give the customer flexibility in relation to the future services requirements. They can also enable improvements or innovations in services, which originate from the marketplace or the supplier, to be implemented into the original contract structure.
Any change request clause must define whether a significant change or merely a slight adaptation (for example, of volumes or service times) is requested. Specific flexible clauses can provide for slight adaptations, such as:
Rolling forecasts (that is, predictive budgeting methods to improve accountability).
Staggered pricing systems (that is, different prices per unit, depending on the amount of units provided).
Changes must often be made to the specification of services or to pricing arrangements. It may be appropriate to agree on a neutral third person to examine:
Whether the requested change is technically possible.
The remuneration.
Although the supplier originally offers services and prices in line with the market, market value can change during the term of the agreement. To ensure that prices continue to be in line with the market, the parties can agree to conduct benchmarking processes, during the term or at the end, to decide whether to renew services.
Benchmarking is carried out either:
By asking an expert to provide a professional opinion.
Through a market price comparison including competitors of the supplier.
Benchmarking requires an exact definition of not only the services to be provided but also of any provisions on liability, including potential caps, provisions concerning change management, and so on. In addition, the contract usually defines the consequences of the benchmarking (for example, whether the customer can (immediately) terminate the agreement or whether the supplier is entitled to provide a last bid).
Generally, the supplier must monitor and keep books about its services and any failures in performance.
The parties can also agree on auditing rights for the customer to ensure that the reports are accurate. An independent third party, such as a firm of certified accountants, typically conducts the audit. The parties must agree on:
The auditor.
The regularity of the audit.
Costs.
The consequences of any deviations.
Appropriate security methods can include:
A bank guarantee for performance claims or for warranty claims.
A letter of comfort from the financially stable parent company.
Appropriate insurance cover.
Parties commonly negotiate specific warranties in addition to the warranties implied by law. The warranties should be drafted together with the service levels, the service level credits and any penalties (see Questions 19 and 20).
Typical warranties given to the customer include:
The right to demand remedy of defects.
The right to decrease the charges.
The right to demand damages.
Certain warranties concerning the assets and goods in the event of insourcing.
A warranty that the services will be provided with reasonable skill and care.
Typical warranties given to the supplier include:
Assignment of warranty claims against third parties.
Warranties concerning legal ownership of rights to be transferred.
Warranties in relation to the correctness and completeness of information relating to the transferred employees.
Generally, the parties include indemnification against third party claims. In addition, the customer can seek indemnification against future liability concerning the insourcing of employees after termination of the outsourcing agreement, and the supplier can request indemnification against historic liability relating to outsourced employees.
Without any contractual specifications concerning the quality of the service, statutory warranties only apply if the services provided do not reach at least an average level.
Regarding fitness for purpose, German law differentiates between works contracts and service contracts. If the service is provided in the form of a works contract, the supplier must provide services to a certain level (that is, it must reach a certain success rate). However, if it is a service contract, the supplier only needs to provide the service, without any warranty for the fitness for its purpose. Unless the parties agree on the specific success of the service or its fitness for a specific purpose, it is for the court to decide whether certain services provided were intended as a works contract or as a service contract.
In a purchase contract, a warranty concerning fitness for purpose varies depending on whether the:
Parties have explicitly agreed on a certain purpose.
Item purchased fits the purpose contemplated under the agreement, in the absence of an explicit agreement.
Item fits the purpose that the buyer usually expects when buying such an item.
Typical provisions regarding limitation in liability and obligations deal with liability for direct and indirect damages, for gross negligence and slight negligence, and for immaterial and material contract breaches.
The supplier may want to limit his overall liability per contract year to a certain percentage of the yearly service charges or limit the liability for each damage claim. The customer may reject any limitation in liability or exclude limitations in certain cases, such as in cases of:
Additional cost of procuring and implementing replacement services in the event of a supplier's default.
Fines, expenses or other losses arising from a breach by the supplier of any applicable laws.
Claims by third parties that arise as a direct result of the supplier's default.
Liability may also be limited to the insurance coverage. Regarding the employee arrangements, the supplier may want to hold the customer liable for inaccurate information regarding the employees to be transferred, for false or not comprehensive information in the information letter and for costs for employees that were not accounted for but were transferred by mandatory law to the supplier. The customer may seek reimbursement for costs for employees who reject to the transfer to the supplier.
Insurance protection covering the following is readily available:
Property damages.
Employer's liability insurance.
Third party liability.
Business protection.
Fidelity insurance.
Insurance regarding employee liability may be discussed with the insurance company on an individual basis. The coverage of business protection insurance can vary depending on the needs of the customer or the supplier.
The law does not impose a maximum or minimum term on outsourcing agreements. Generally, outsourcing contracts last for five to ten years.
National law does not impose an explicit maximum or minimum notice period. The supplier and customer can agree on notice periods.
There is no notice period for extraordinary termination with good cause under section 314 of the BGB (see Question 31). The contract comes to an end at the moment the notice is served, provided the customer has given the supplier either a:
Warning letter.
Opportunity to remedy the situation if the termination is for failure to perform a contractual duty.
However, in certain circumstances, the party serving notice can be required to grant the other party a phasing-out period if this is necessary to protect the other party's interests. This allows the contractual relationship to continue for a limited time to enable the parties to make all necessary arrangements for ending the contractual relationship. In addition, the terminating party must terminate the contract within an appropriate time period after receiving knowledge of the reason for termination. The supplier can ask for a continuation of the service after termination in case of insourcing of the services or transfer of the services to another provider.
Extraordinary termination requires good cause to terminate the agreement. There is good cause if, when considering all circumstances and the parties' mutual interests, continuation of the agreement is unacceptable for the terminating party. The other party's default is not required.
A termination right for insolvency is subject to section 119 of the Insolvency Act (Insolvenzordnung (InsO)). An agreement is invalid if it excludes or restricts either the:
Insolvency procedure.
Insolvency administrator's freedom to choose whether he wishes to fulfil a contract.
The other event that justifies termination is frustration of the contract (Wegfall der Geschäftsgrundlage).
The parties can agree additional termination rights such as an option for ordinary termination (that is, the parties have a right to terminate the agreement with notice for any or no reason) even within the fixed term. This agreement may contain provisions concerning a compensation payment for early termination.
The outsourcing agreement commonly sets out grounds for extraordinary termination, including:
Non-payment of the service fee by the customer.
Serious non-performance of the service level agreements by the supplier.
Change of control.
The parties can also agree on an extraordinary or ordinary termination for convenience, which usually includes compensation payments by the terminating party.
The continued use of licensed IP rights post-termination depends on the specific terms of the licence. The customer does not usually grant a licence post-termination unless there are certain benefits to doing so. Without any specific provisions, it is generally implied that the licence terminates with the outsourcing agreement.
The customer cannot gain access to the supplier's know-how after termination of the outsourcing agreement, unless good faith demands this or it is explicitly stated in the agreement. Good faith may be given if the customer cannot continue its business at all without the supplier's know-how. Therefore, the parties should contractually agree on transfer of know-how post-termination. The customer can make use of the know-how of insourced employees unless this know-how is protected by confidentiality agreements or as a business secret of the supplier.
Liability can be, and usually is to a certain extent, contractually excluded unless it is mandatory under law. Mandatory liability includes intentional acts and claims based on product liability. If the parties have agreed on certain penalties relating to service levels (see Question 25, Warranties), liability clauses should reflect these penalties. Unless prohibited by mandatory liability, the supplier may exclude liability for indirect and consequential loss as well as for any loss of business, profit or revenue. If the terms of the outsourcing agreement are considered to be standard terms and conditions under section 305 of the BGB, liability for any intentional or negligent injury to life, health or body is mandatory. In addition, liability for gross negligence can only be restricted in limited cases.
The parties are free to agree a cap on liability unless liability is mandatory under German law (see Question 35).
Liability is typically limited to a fixed amount or a percentage of the contract value, or a combination of these. The supplier aims to:
Have different caps in place for gross and slight negligence.
Exclude liability for indirect and consequential damages, and loss of profit.
Tax liabilities depend on whether the outsourcing is structured as an asset or a share deal (see Question 5, Asset or share deal).
Asset deal. In an asset deal, the sale of the assets affects the customer's income tax liability. One of the main tax issues that may arise is revealing hidden reserves through the sale of assets. Depending on the outsourcing transaction, the customer can structure the transfer so as to either:
Prevent revealing hidden reserves.
Transfer hidden reserves on a tax-free basis.
The transfer of assets can otherwise be tax free if certain conditions are met under the Reorganisation Tax Act (Umwandlungssteuergesetz (UmwStG)).
Stamp duty of up to 3.5% can arise on real property transfers.
Share deal. In a share deal, tax implications depend on the customer's legal form. If the customer is a:
Corporation, the transfer of shares is regulated by section 8(b) of the Corporation Tax Law (Körperschaftsteuergesetz (KStG)). Under certain circumstances, the capital gain is exempt from corporate income tax in addition to excise tax.
Partnership, the transfer of the shares is regulated by section 3, No. 40a of the Income Tax Law (Einkommensteuergesetz (EStG)).
If the supplier becomes the new employer of the transferred employees, it takes on all the customer's responsibilities towards those employees (see Questions 7 and 8). It must withhold income tax and social security contributions from the employees' salaries, and transfer them to the respective authorities.
For the customer, payment for services or goods being supplied is subject to the applicable rate of VAT (19%).
Generally, certain services provided by banks and financial institutions are exempt from VAT (section 4, No. 8 VAT Code (Umsatzsteuergesetz (UstG))). If a financial institution outsources financial services to the supplier, there is a risk that the services provided by the supplier may not fall within the tax exemption and that VAT obligations will arise. This has become a significant issue in the financial services sector and should be carefully examined in each particular case.
The German VAT also applies to services.
There is no stamp duty as such in Germany.
Different corporate taxes in different countries should be taken into consideration when a customer intends to outsource services to an internal service provider. The supplier can be established in a different country for tax purposes, but double tax agreements may limit the benefits.
There are no other significant tax issues.
T +49 89 20304 10
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E srippert@reedsmith.com
W www.reedsmith.com
Qualified. Germany 1992; New York, US, 1996
Areas of practice. IT/media; commercial/corporate.
Recent transactions
T +49 89 20304 130
F +49 89 20304 199
E rlochmann@reedsmith.com
W www.reedsmith.com
Qualified. Germany, 2003; New York, US, 2002
Areas of practice. Financial services; banking/finance and regulatory; real estate finance.
Recent transactions
T +49 89 20304 10
F +49 89 20304 199
E kweimer@reedsmith.com
W www.reedsmith.com
Qualified. Germany
Areas of practice. Data protection; IT/media.
Recent transactions
T +49 89 20304 10
F +49 89 20304 199
E jweissgerber@reedsmith.com
W www.reedsmith.com
Qualified. Germany
Areas of practice. Employment; labour.
Recent transactions
