Statutory security devices in construction contracts in France and Germany, a challenge to the parties´ freedom of contract favoured by the FIDIC terms

by | 22. February 2014 | Commercial Law

In the past standard forms for international construction contracts did not include any type of security device covering compensation claims of the contractor other than a sample form of a Payment Guarantee which is actually rarely used in practice. It took until 1999 when the new editions of the FIDIC forms (also referred to as the Rainbow Edition) were published, to change this. To the pleasure of all contractors clause 2.4 (Red Book) provides:

The Employer shall submit, within 28 days after receiving any request from the Contractor, reasonable evidence that financial arrangements have been made and are being maintained which will enable the Employer to pay the Contract Price (as estimated at that time) in accordance with Clause 14 [Contract Price and Payment]. If the Employer intends to make any material change to his financial arrangements, the Employer shall give notice to the Contractor with detailed particulars.

The new FIDIC Gold Book includes a similar clause. Despite some debate about the clear meaning of parts of Sub-Clause 2.4 it has become a widely accepted clause. Employers should note that Sub-Clause 2.4 uses the term evidence which is presumably more than a mere statement. They should also note that the Contract Price “as estimated at that time” presumably means something else than the Contract Price as already adjusted by means of a determination in accordance with Sub-Clause 3.5. Thus, if there is an instruction which constitutes a Variation, the amounts due for the Variation should be included.

However, much higher standards have been achieved under German and French law. In both countries the contractor (architects and engineers as well) can either demand that the employer grants a mechanics´ lien in the form of a mortgage on the parcel of land upon which the buildings are erected (see Section 648 para. 1 German Civil Code) or such a mortgage is imposed upon this land by statue (art. 2103 French Civil Code). Of course both types of security devices are only available if the substantive law applicable to the contract is either French or German law.

Moreover, even stricter rules can be found in Section 648 a German Civil Code and in art 1799-1 French Civil Code. Under the German provision the contractor may suspend all his duties to perform until the employer has found a bank that is willing to stand surety for the employers´ debt. This regulation and its French counterpart are mandatory. The parties can not contract out of them (see for example the German case High Court Koblenz – 4 HK .O. 25/13- November 26, 2013). This is a big issue for foreign employers especially for those who are not familiar with German and French law.

So, how works the statutory mechanism of German law?

According to § 648 a paragraph 1 German Civil Code (in its version until 31.12.2008, see for the new version below) contractors for all buildings or external installations or parts thereof except for public building contracts or those for the erection of single family dwelling homes can demand from the employer a security for works done and to be done (German Supreme Court in BGHZ 146, 24, 31) including ancillary claims such as interest. The contractor can do so by setting a reasonable period of time during which the employer has to find a surety, usually a financing bank, and by declaring that he will refuse to perform after this period has expired. Security may be demanded up to the probable amount of compensation under the main contract or a subsequent supplementary contract plus ancillary claims. The latter are estimated at 10% of the major compensation claim. However, it is sufficient if the surety reserves the right to revoke the security in the case that financial circumstances of the main debtor, namely the employer, materially deteriorate. This revocation is effective only in respect to compensation claims for works not yet completed at the time the revocation is received by the employer (German Supreme Court in BGHZ 146, 24, 35)

The security device can be in the form of a guarantee or other promise to pay for the employers´ debt made by a credit institution or credit insurer authorised as such within Germany. However, the credit institution or the credit insurer only has to pay to the extent that the employer acknowledges the contractor’s claim or after the contractor has obtained a money judgment against the employer and the conditions for enforcement of this judgment are met.

On the other hand the contractor has to bear the usual costs for providing this security up to a maximum rate of 2% of the amount secured annually (Section 648 a para 3 German Civil Code). This does not apply if the security has to be extended because the employer raises defences against the contractor’s compensation claim, typically major defects, and these defences turn out to be unfounded.

The claim to provide a security in the form of a mortgage under Section 648 para. 1 German Civil Code is excluded in so far as the contractor has obtained a security for his claims under sub paragraphs (1) and (2) of Section 648 a German Civil Code.

The consequences of a failure to comply with Section 648 a German Civil Code are drastic. The general rule is that a court will treat the parties as if the contract had been terminated. The rights of the contractor are regulated in Sections 643 and 645 para. 1 German Civil Code. Under these provisions the contractor may even be entitled to compensation for all losses incurred as a result of his reliance on the validity of the contract.

On January 1st, 2009 a new version of Section 648 a German Civil Code has come in force. The old Section 648 a para. 2, 3, 4 and 7 remain unchanged. However, the new version slightly simplifies the exit option (Section 648 a para. 5). Henceforward once the contractor has made an request for a security with reasonable notice he may totally suspend progress of the works (see Court of Appeal Jena -2 U 34/12- November 7, 2013, (2014) IBR 146 – Rodemann) and/or terminate the contract, if the employer does not comply with its duty to provide security. It also makes clear that Section 648a German Civil Code even applies if the works have already been handed over. It is also worthwhile to note that in the event of a ternination notice the contractor is entitled to 5 % of the remaining contract price with regard to any outstanding work under the contract. The most important new feature of Sect. 648 a German Civil Code is, that it provides for an enforceable right to request a security. Under the old version the Contractor was only entitled to suspend progress of the works and to terminate the contract if the employer failed to comply with a request under Section 648 a German Civil Code. Henceforward specific performance is admitted.

Aware of this employers might be tempted to avoid these disadvantages that German and French law impose upon them by agreeing that e.g. English law, under which these statutory rights are unknown, shell govern the contract. However, contractors who do so should be aware of the fact that art. 1799-1 French Civil Code is a part of the French “ordre public”. This means that art. 1799-1 French Civil Code will be applicable even if the proper law of the contract is English law. The only way out to avoid this provision is to combine the choice of law clause with a jurisdiction clause in favour of the English courts as well. But even this does not entirely ensure that the rights under art. 1799-1 French Civil Code will not apply. Concerning German law there is no court decision holding that § 648 a German Civil Code is a part of the German “ordre public”. However, our answer is clearly: Yes.

The bottom line of all of this is this: the German and the French legal systems are much more advantageous to contractors than common law jurisdictions. Not only France and Germany have statutory provisions as the ones outlined above, in Switzerland and Turkey similar provisions are in force, which entitle the contractor to demand that the employer grants a mortgage on the land where the site is located.

The FIDIC forms of contract do not exclude or alter these statutory security devices currently in force in the abovementioned countries at all. Thus, Sub-Clause 2.4 FIDIC 1999 is an additional or complimentary feature.

WARNING: the material contained in these notes is a simplified guide to some of the major topics in international and German construction law. It is not intended as a substitute for legal advice on individual transactions, and does not necessarily stand on its own. Whilst the contents are believed to be correct, the authors cannot accept any responsibility for errors or omissions