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Suspension rights: Civil Law Jurisdictions

The right to suspend work or payment seems to be the legal weapon that comes in most handy to both the contractor and the employer when struggling with their respective counterpart since simply nothing needs to be done in order to assert one's rights - or so it seems.

As we saw in the Autumn 2004 Edition of this newsletter things are not quite as simple as they seem. In England, and in other common law jurisdictions, courts are likely - in the absence of justification by contract or by legislation - to regard suspension of fundamental obligations as a repudiation of the contract.

We will now take a closer look at how this issue is dealt with under the civil law as applied in Germany.We will see why the German Civil Code ("BOrgerlichesGesetzbuch"or "BGB") at first sight is likely to turn the common law lawyer'sconstruction world upside down, but that when it is applied, it is not so different after all.

While under common law the suspension of fundamental obligations is seen as an exception and has only fairly recently been enacted in the HGCRAct', suspension rights under the BGB are the rule. Where as standard form contracts under common law step in to provide the rights to suspend in certain cases, parties to German construction contracts are more likely to try to abolish such rights - of course much to the disadvantage of the other party.

Rights to suspend granted by statute

p>The right to suspend performance is one of the main remedies provided by the German Civil Code. It is derived from the principle of good faith according to which a party acts against good faith if it claims performance under any legal relationship while at the same time not performing its own due obligations (Section 273 Para. 1 BGB).

While this provision applies to all legal relationships, there is a special statutory provision for the right to suspend performance in bilateral (synallagmatic) contracts.

Section 320 BGB provides each party to a contract with a right to suspend performance of its obligation until the other party has performed its part. This does not apply if the party intending to suspend is obliged to perform first.

The question is therefore: Who is obliged to perform first?

Although this question is often difficult to answer, the law surrounding construction contracts is clear. Section 641 Para. 1 BGB provides that remuneration shall be paid upon acceptance of the work. In other words, a contractor will only be paid if his work is completed in accordance with the contractual requirements and is accepted by the employer. Before acceptance of the work the contractor - in absence of contractual provisions to that effect - generally has no right to suspend under Section 320 BGB.

Moreover, even if the contractor has finished its work and is thus entitled to payment, the employer can still refuse such payment after acceptance if the work has a defect. Under Section 641 Para. 3 BGB the employer is entitled to suspend payment equivalent to three times the expected costs of remedying the defects.

Would the Nobles, owners of Stortford Lodge in Hertfordshire, England, who stopped interim payments to their builder for lack of progress and were told by court that by doing so they had repudiated the contract, have been better off had they chosen German law? At first glance yes, because generally payment is due only after acceptance of the work.

It is quite clear that the "bare" regulations under the BGB bring big risks for a contractor as he must finance in advance all material and labour costs and bears the risk of the employer becoming insolvent during the course of performing the contract.

One way of reducing this risk is to agree on advance payments so that the contractor has enough funds to start the works. However, the contractor is often obliged to give security for such advance payments in the same amount, e.g. a bank guarantee, which may put a strain on its credit facilities.

In 2002 the federal legislator enacted the "Act for the acceleration of due payments" which inserted into the BGB a statutory right of the contractor to demand interim payments on account.

Under Section 632 Ut. a BGB the contractor has the right to demand interim payments on account:

  • for individual self contained elements of the work which means parts that constitute a value of their own for the employer (e.g. completing one roof if the contractor has to build several roofs); or
  • if necessary materials or construction elements have been specially made or delivered; and
  • if these self-contained elements of work, materials or construction elements pass into the employer's ownership; or
  • if and, as far as ownership does not pass, if the contractor provides security for the interim payments on account.

You will notice that the requirements for the claim for interim payments on account are quite substantial. Moreover, it is often not always clear if the completed part is in fact self-contained. A clear definition has not yet been found. Therefore the contractor should only exercise its right with great care because if he suspends without due cause the other party will be entitled to:

  • suspend payment on its part for non performance of the other party; and
    • e
  • ventually terminate the contract and claim damages if work is not resumed upon adequate notice.

However, if these requirements are met and the employer defaults in paying the interim payment on account, the contractor has a right to suspend further works under Section 320 BGB since its obligation to perform first is suspended until such interim payment has been effected.

Returning to the Nobles' case: had their obligation to pay interim payments on account been created under Section 632 lit. a. BGB because the contractor had, for example, finished one of five roofs, they would have been in default with payments to the extent that the contractor had - although being slow met the statutory requirements. The contractor would be entitled to suspend further works immediately and - having given the Nobles an adequate notice claim damages and/or rescind the contract.

Suspension right for outstanding. security

Another way for the contractor to circumnavigate the perils of first performance is to demand security under Section 648 a BGB.

Under Section 648 a BGB the contractor:

  • is entitled to request at any time security in the amount of the expected value of the outstanding work plus 10 % of this amount for ancillary claims in advance;
  • has a right to suspend if the employer does not comply with this request after the contractor has given the employer adequate notice of the intention to suspend; and
  • may even terminate the contract, having given further adequate notice to the employer of its intention to terminate, should the requested security not be issued. In addition the contractor can claim payment for the proportion of the performance carried out until termination and reimbursement of additional expenses. Finally, it has a right to claim damages for default of the employer.

This regulation is mandatory. Even in commercial construction contracts, neither party can waive it. Quite often this right to security is used as a means to counterattack the suspension of payment by the employer by reason of defects. This is possible because amounts retainable by the employer for defects do not reduce the amount of the contractor's claim for security. If the employer does not provide such security in the full amount, the contractor can suspend its work. If, however, the contractor subsequently chooses to terminate the contract, he can only claim the contractual remuneration less the amount that is needed to fix defects - a wide field for controversy.

Suspension rights provided for under VOBIB

Unlike in the UK there are no standard form contracts in common use in Germany. The content of a construction contract is determined by the statutory regulations and frequently by the Award Rules for Building Works ("Vergabe- und Vertragsordnung fOr Bauleistung", "VOB"). The German Award Committee for Building Work ("Deutscher Verdingungsausschuss fOr Bauleistungen") is responsible for the regular revision of these award rules.

Part B of the VOB ("VOB/B") contains provisions regulating the legal relationship between the employer and the contractor from the time of conclusion of the construction contract until its complete fulfilment. The provisions of VOB/B are only applicable if the parties expressly agree their applicability. They modify the regulations under the BGB in order to make them more suitable for the needs and particularities of a construction contract, e.g. the unilateral order of change in performance under Sect. 1 no. 3 and 4 VOB/B.


The BGB regulations remain applicable unless the VOB/B derogates from them. Therefore in principle all of the above mentioned provisions remain applicable as well as the possible suspension rights arising thereunder. The contractor is still obliged to perform first.

Suspension for employer's default relating to interim payments on account

The contractor under a VOB/Bagreement is entitled to interim payments on account in the amount of the workslservice proven to have been performed upon request, if possible in short intervals (Section 16 no. 1). The requirements under Section 632 lit. a. as mentioned above (individual selfcontained part, passing of ownership, if needed security) need not be met. The contractor only has to present an invoice showing the status of the progress of the service and can claim interim payments on account for the full value of the invoice (often discounts are agreed so that only 90-95 % are actually paid out at this stage). Of course the employer can deduct three times the value of any counterclaims he has, especially for defects in the workslservice performed.

The Nobles, being dissatisfied with the progress of the work, would only be obliged to pay for the actual work done if the VOBIB was agreed to apply to their construction contract. If the works (value EUR 40,000) were defective, and the remediation costs were calculated to be EUR 15,000 the Nobles would not be under any payment obligation since they could deduct EUR 45,000 (3x EUR 15,000) leaving a negative balance.

The right to claim interim payments on account leads to a payment obligation of the employer long before acceptance of the work. Such claims fall due within 18 days from the receipt of the invoice. The contractor has a right to suspend further service if:

  • the employer does not pay a justified
    • after th
  • e contractor has sent a reminder and given further adequate(short) time limit for payment; and
  • the contractor has announced its intention to suspend.

Apart from suspending work, the contractor can claim statutory interest on the outstanding amount. The contractor is also entitled to damages under section 6 no. 6 VOBIB if the employer is responsible for the delay arising out of the suspension which arguably will most likely be the case if he defaults on due payment. Damages will cover loss of profit only if the employer acts with gross negligence or fault, which will often be the case. Also, the contractor can claim an extension of time under section 6 no. 2 VOBIB or can terminate the contract under Section 9 no. 1 Lit. b VOB/B.

If the employer only makes unjustified deductions from the payment the contractor must in each individual case balance whether the suspension of works is justified compared to the outstanding amounts. The contractor seeking to suspend does so at its own peril for if it suspends frivolously it is in breach of contract which gives the employer the right to suspend payments and, having set a time limit to take up tools again and announced termination, even a right to terminate the contract and claim damages (Section 5 no. 4, section 8 no. 3 VOB/B).

Suspension for lack of agreement on additional remuneration?

Under the terms of section 1 no. 3 VOBIB the employer is entitled to order changes to the agreed work. Section 1 no. 4 VOBIB provides that the contractor must, at the employer's request, also carry out work that was not originally agreed but that becomes necessary for the execution of the contractual works.

The financial interests of the contractor are safeguarded in these cases by the possibility of adjusting the remuneration under the terms of section 2 no. 5 VOBIB (changes of work), Section 2 no. 6 VOBIB (additional work) and section 2 no. 7 sentence 4 VOBIB (changed and additional work in lump sum agreement).

In cases of alterations to works, e.g. due to an alteration of the building draft, or where additional services are required, an altered price shall be agreed pursuant to the above mentioned provisions prior to execution of such altered or additional work.

What happens if - which is very often the case - the parties cannot agree on such additional remuneration? Mostly parties differ in their reading of the scope of service under the original contract, especially in lump sum contracts. Also the basic calculation of the additional remuneration might be in question. Is the contractor entitled to suspend work or at least the altered or additional work if such agreement is not reached bearing in mind that the contractor generally is obliged to perform first?

Many contractors seem to believe so but the German Federal Court has only recently decided this question following the classic risk allocation under BGB construction contracts:

  • if the employer accepts in principle that the contractor is entitled to additional remuneration but the amount is in question, the contractor does not have a right to suspend since it is obliged to perform first;
  • if, however, the employer ultimately refuses additional payment, the contractor may suspend that part of the work that is subject to such additional payment until an agreement is reached.

Conclusion

This brief and by no means comprehensive article on suspension rights in construction contracts in the legal framework of the German BGB and the VOBIB demonstrates that the right to suspend performance, although generally accepted by the law, must be exercised with great care - especially with regard to the relevant formal and material requirements.

Unjustified suspension will always lead to costly consequences, including the possibility of termination of the agreement.

Thomas Reischauer & Sabine Schutz
Clifford Chance International Construction Newsletter
Spring 2005

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