Contract for Work and Materials – Legal Aspects & Fundamentals

Contracts for Work and Services for Businesses

The contract for services is governed by private law. Under this contract, two parties agree—in accordance with the principle of freedom of contract—to provide reciprocal services. Both parties protect each other’s interests through claims regarding performance, compensation, warranty, and more.

For companies, contracts for services offer the opportunity to outsource individual tasks or even entire areas of responsibility from their own operations to another company or to a self-employed individual. This enables the client to save costs, deploy personnel more flexibly, and respond more easily to market developments. Contracts for work have become particularly important when it comes to hiring freelancers.

Contracts for Work and Services They offer businesses a wide range of cost-effective applications. These include the skilled trades as well as the real estate, marketing, and software sectors, among others. For example, contracts for work and services are frequently used to renovate buildings. They are also used in the development of new software solutions by contracted IT companies.

One of the distinctive features of contracts for work in this field is the flexibility of their scope. For example, a large company or a single freelancer can be commissioned to develop a software solution. Depending on the desired outcome, this offers advantages ranging from higher quality of work and greater expertise to significant cost savings.

The Work Under a Contract for Services

A contract for work and services is intended to have a contractor perform a specific task for a client. The client specifies the details of the work and when and in what form it is to be ready for acceptance. In the second step, the contractor carries out the work and, upon successful completion, receives the agreed-upon compensation.

What exactly is a “work”? According to Section 631(2) of the German Civil Code (BGB), a “work” is, by definition, the creation of an object—but it can also consist of the alteration of an object. If a website is created, this constitutes the creation of an object. If, on the other hand, a house is renovated, this constitutes the alteration of an object.

Furthermore, Section 631(2) of the German Civil Code (BGB) also defines a result brought about by work or a service as a work. For example, if an expert opinion is prepared, the result was brought about by work.

In each of these cases, the work is performance-based. It is not sufficient for a contractor to begin performing the work but fail to complete it. If the work to be performed consists solely of the provision of labor, a service contract—rather than a contract for work and materials—applies. A service contract is not contingent on the successful completion of the work.

Defects and Withdrawal from a Contract for Work and Materials

If the contractor completes the work within the contractually specified time limit, the client is obligated to accept the work. This is provided for in § 640 of the German Civil Code (BGB). However, acceptance is precluded if the condition of the work prevents it.

When is the acceptance of a work prevented?

• Acceptance of the work may be prevented or refused whenever there is a material defect.
• The right of withdrawal is subject to the statutory warranty rights.
• If the defect in question significantly reduces the value of the work or significantly impairs the work's suitability for its intended use.
• Section 323 of the German Civil Code (BGB) expressly precludes rescission if the defect is not material—that is, if the breach of duty is only minor in nature.

When is a defect considered material or significant?

Especially when creating larger works, defects often arise that are not significant when considered individually. For example, if the plaster on a house is not complete in every spot, that does not constitute a significant defect. However, if minor defects accumulate, they may, when viewed as a whole, result in a significant defect.

Once a work has been completed, it must, as a general rule, be suitable for its intended use and conform to the description set forth in the contract. In the case of a house, it follows from its very nature that it must be habitable. If the roof leaks, this constitutes a clear defect—which may be significant or insignificant, depending on the extent of the leak.

Software example: If it has been specified that search queries must return a result within 5 seconds, but it takes 8 seconds, the defect is not significant. If the search queries return no results at all, this constitutes a significant defect.

As a general rule: If the cost of remedying the defects exceeds 10 % of the contract price, the defects are considered significant. If the technical or time-related effort required is too great, or if the aesthetic appearance is significantly impaired, the defect is also considered significant.

The Consequences of Withdrawal and the Right to a Price Reduction

The withdrawal must be expressly declared to the other party to the contract. The contractor has the right to demand the return of the materials. If this is not possible, the contractor may exercise its right to compensation for the value of the materials.

Disputes often arise in court over whether a defect is of a material nature. Therefore, it may be advisable to forgo the right to rescind the contract and instead exercise the right to a reduction in price. This allows the client to reduce the compensation for work performed in proportion to the defects and the costs of remedying them. Important: The right to rescind the contract and the right to a price reduction are mutually exclusive.

Rescission of a Contract for Work and Services

When a contract for work and services is concluded between a consumer and a business, certain additional provisions apply, including the right of withdrawal. This right applies whenever the contract for work and services was concluded via means of distance communication (email, telephone, fax, letter) or outside of business premises. In such cases, the consumer has the right to cancel the contract within 14 days.

However, this time limit applies only if the business informs the consumer of it before the contract is concluded. If this does not occur, the consumer has the right to rescind the contract within 12 months. It is therefore advisable for businesses to include information about the right of rescission in their terms and conditions.

The consumer construction contract is governed by different rules: In this case, the means of communication used to conclude the contract are irrelevant. The consumer may terminate the contract at any time without notice.

Commencement of work before the end of the cancellation period

If the contractor begins work before the 14-day period expires and the consumer subsequently revokes the contract: The consumer may revoke the contract for work and services after receiving the required notice, even if the contractor has already begun work.

With regard to services already rendered, the business may demand payment—but only if it has received written confirmation from the consumer before the end of the cancellation period and before work begins, stating that the consumer agrees. In the absence of such confirmation, the contractor cannot demand payment for services already rendered. In the event of a cancellation, the law requires that the consumer be restored to the same position as if the contract had never existed—which may also entail restoration at the contractor’s expense.

Important Rules Regarding Cost Estimates

Before a contract for work and services is concluded, a cost estimate is usually prepared. Unless otherwise agreed, no compensation is paid for preparing the cost estimate. If the contractor expects compensation for this, it must be expressly agreed upon with the client before the contract is concluded. A provision in the general terms and conditions is not sufficient for this—consent to cover the costs must be given in each individual case.

If the actual costs incurred significantly exceed the agreed-upon amount, the contractor must notify the client immediately. In that case, the client has the right to withdraw from the contract. If the client does not exercise this right, the client accepts the higher costs. If the contractor negligently fails to provide this notice, this may result in liability for damages.

Acceptance of the Completed Work

If the work has been successfully completed in accordance with the description, it must be accepted by the client. Acceptance is a prerequisite for payment—no acceptance, no payment. Prior to acceptance, the contractor bears the risk of deterioration or destruction of the work. After acceptance, this risk passes to the client.

Upon successful completion of the work, the contractor has the right to request that the client accept the work and to set a reasonable deadline for such acceptance. If the client does not accept the work within this deadline and does not respond, acceptance is deemed to have taken place—it is legally considered to have been properly completed.

If acceptance is refused

If there is a material defect, the customer has the right to refuse acceptance. Minor defects do not justify refusal—but they do entitle the customer to request rectification. A defect is minor if the work was predominantly performed in accordance with the contract and the customer can reasonably be expected to accept it.

Wages & Advance Payments

The Due Date for Payment of Wages for Work Performed

Payment for work performed may only be claimed once it is due—usually upon acceptance of the work. Contractual relationships with subcontractors are to be handled differently: According to Section 641(2) of the German Civil Code (BGB), payment for the work must be made if the developer or general contractor has received payment from the client, acceptance has taken place, or the subcontractor has set a deadline for acceptance and that deadline has passed without result.

The Payment of Installments

As a general rule, the contractor is required to perform first. However, it is not uncommon for the client to make installment payments for larger and longer-term projects. The amount is based on the value of the work performed and the work still owed, using the agreed-upon compensation—including value-added tax—as the basis.

• Was a Flat rate If agreed, a portion of the total compensation shall be paid, calculated based on the value of the services actually rendered relative to the total value.
• If there is a material defect If this is the case, the progress payment cannot be withheld—the work has not yet been completed, and defects can still be corrected. However, the client has the right to withhold twice the estimated cost of correcting the defects (quality assurance surcharge).
• If a A structure for a single user If the work is constructed or remodeled, the contractor may request a maximum advance payment of 90 % of the total compensation. Upon receipt of the first advance payment, the contractor must provide a security deposit of at least 5 % of the total compensation.

Defects – Claims and Rights in the Event of Defects

Under Sections 633(2) and (3) of the German Civil Code (BGB), a work may be subject to two types of defects upon completion: a defect in quality or a defect in title.

A Defect in the goods A defect exists if the work does not possess the quality agreed upon in the contract. If neither party has expressly specified the quality, a material defect exists if the work is not suitable for the use specified in the contract, cannot be used for its ordinary purpose, differs in quality from other works of the same kind, the quantity produced is too small, or a work other than the one intended has been produced.

A Legal Defect This occurs when a third party can assert a right with respect to the work created that has not been transferred to the client under the contract for services—typically, an infringement of industrial property rights.

The Right to Subsequent Performance (Remedy of Defects)

The client’s first right in the event of a defect is the right to subsequent performance: The client reports the defect, and the contractor must remedy it—either by directly correcting the defect or by re-producing the work. To legally demand subsequent performance, the client must expressly request that the contractor remedy the defect and describe it in detail, but is not required to prove its cause.

It is recommended to set three deadlines with regard to subsequent performance: (1) a statement of willingness to remedy the defect, (2) the start of work, and (3) completion of the remedy. The request should be made in writing. The contractor shall bear the costs of remedying the defects (materials, labor, transportation).

The contractor may refuse to perform remedial work if doing so would entail disproportionately high costs (Section 635(3) of the German Civil Code (BGB)). In this case, a reduction in the contract price or—if the conditions are met—compensation for damages is possible.

The Right to Perform the Action Oneself or Have It Performed by Another

If the contractor fails to comply with the request for subsequent performance and the set deadline has passed, the client is entitled to perform the work himself or have it performed by a third party: He may remedy the defect himself or hire another contractor. He may demand an advance payment for the costs or invoice the client for the expenses incurred.

As an exception, no deadline need be set if the contractor has seriously and definitively refused to remedy the defects, the remedy is delayed, and the customer no longer has any interest in the service, special circumstances require immediate self-performance, or a previous attempt at subsequent performance has failed.

The Right to Cancel or Seek a Price Reduction

The client may choose not to accept subsequent performance and instead rescind the contract or reduce the compensation—in either case, a deadline for subsequent performance must first have been set. Rescission requires the existence of a material defect and is precluded if the client is primarily at fault for the defect.

The Right to Compensation

If the deadline for subsequent performance has passed without success and the contractor is at fault for the defects (even simple negligence is sufficient), a claim for damages arises. Compensation is based on the principle of restoring the client to the position they would have been in had they received the defect-free work. Compensation must cover both damage to the work itself and damage to other persons or property.

The Statute of Limitations on Claims for Defects

Claims arising from defects are subject to statutes of limitations:

• General Claims for Defects: 2 years from the date of acceptance of the work
• Construction Projects (Construction of structures, planning, supervision): 5 years upon acceptance
• Intangible works: 3 years from acceptance
• Fraudulent Concealment of a Defect: 3 years, beginning at the end of the year in which the claims arose and the client became aware of the defect. In the case of a 5-year statute of limitations (for structures), the statute of limitations does not begin to run until after the 5 years have elapsed.

A statute of limitations may be limited by individual agreement—but not if the defect was fraudulently concealed or if the contractor provided a warranty of quality. Provisions in the general terms and conditions are not sufficient for this purpose.

Fraud is present when there is deliberate deception: The contractor was aware of the defect but remained silent in order to ensure successful acceptance.

Disputes Arising from Contracts for Work and Services

It is common for conflicts to arise from contracts for services. Going to court often involves costs and a significant time commitment. Therefore, ADRs (Alternative Dispute Resolutions) are a good option, as they can produce an acceptable outcome in a shorter timeframe and at a lower cost:

• The use of a Business Mediation, in order to negotiate a valid agreement
• Going to a Arbitration Tribunal, in order to obtain a binding judgment
• The creation of a Arbitration Award, to serve as the basis for a negotiated solution

For larger projects, contracts for services often include a clause regarding the use of mediation or arbitration as early as the time the contract is signed—which increases legal certainty from the outset.

Construction Contracts – Special Provisions

The provisions governing construction contracts are set forth in Sections 650a–650h of the German Civil Code (BGB). They govern aspects related to the specific characteristics of construction projects: the construction and restoration of structures, demolition and renovation, outdoor facilities, and maintenance work, provided that such work serves the construction of the structure or is necessary for its continued existence.

The special provisions include:

• A specific right of the purchaser to issue instructions
• Acceptance with a joint assessment of the condition
• A final invoice that can be audited
• The Requirement for Written Notice in the Event of Termination
• The Construction Trades Insurance

The Purchaser’s Right to Issue Instructions (§ 650b BGB)

The client is granted a special right to issue instructions: He may order additional services not specified in the original contract for work and have the contractor compensate him for them. Specifically, the client may request: a change to the specified outcome of the construction project (if certain aspects were not taken into account in the original planning) or a change to the plan that is necessary for the successful completion of the work (in the event of an incomplete scope of work or a change in the legal situation).

The right to issue instructions is not unlimited—the contractor is only required to comply with the changes if doing so is reasonable for the contractor. The contractor may submit a revised proposal reflecting the changed scope of work (time, risk, management, profit) or based on the original calculation (Section 650c(2) of the German Civil Code (BGB)).

If no agreement is reached, the client may order the change in writing. If no agreement is reached within 30 days of the order, the contractor must comply with the request to the extent reasonably possible.

Acceptance with a Joint Condition Assessment

If the client refuses to accept the work, the law provides for a joint inspection of the condition of the work, which the contractor may request. As part of this assessment, documentation is prepared that will be used to establish the facts in the event of a potential lawsuit. If the client does not comply with the request, the contractor may conduct the assessment unilaterally.

The auditable final invoice

Under the construction contract, the contractor’s payment is not due until the contractor has submitted a verifiable final invoice: The individual line items must be listed and understandable to the client.

Termination in Writing

If notice of termination is given for a construction contract, it must be in writing. This takes into account the increased importance and greater effort involved in the construction of a building.

How to Properly Terminate a Contract for Work and Services >>>

The Construction Trades Guarantee (§ 650f BGB)

The contractor may require a construction guarantee: The client must provide security for the work to be performed. The security deposit constitutes a separate claim and may be enforced as such. The amount may not exceed the claim for the contract price and may still be demanded even after acceptance has taken place or if claims for defects have been asserted.

The amount of the security deposit corresponds to the unpaid compensation plus outstanding additional orders and incidental claims (up to 10 % of the compensation claim). If the client fails to provide the security within the specified time limit, the contractor may refuse to perform the work or terminate the contract. In the event of termination, the contractor receives the agreed-upon compensation minus any savings in expenses; the law presumes that the contractor is entitled to 5 % of the value of the work not yet performed.

Consumer Construction Contract

The provisions governing consumer construction contracts are set forth in Sections 650i through 650n of the German Civil Code (BGB). Requirements: The client must be a consumer (a natural person acting for private purposes), and the construction project must consist of the new construction of a building or a substantial renovation, and must be performed by a single contractor (general contractor or general manager).

The following provisions apply to consumer construction contracts:

• The contract is concluded in writing (PDF, fax, email).
• The consumer must receive a written description of the construction work.
• A deadline for completion must be set.
• Before the contract is concluded, the consumer must be informed of his or her 14-day right of withdrawal.
• Installment payments may not exceed 90 % of the total compensation.
• A security deposit equal to 5 % of the agreed-upon compensation must be provided with the first installment payment (in the form of a withholding or a guarantee).
• The consumer must receive the relevant planning and construction documents in order to provide proof to government agencies and banks.

Architect, Engineer, and Developer Contracts

Architectural and engineering contracts are governed by Sections 650p through 650t of the German Civil Code (BGB). They cover the design of a structure and its corresponding construction—and entail several obligations: successful design, supervision, and completion of the structure.

In the case of real estate development contracts (Sections 650u through 650v of the German Civil Code (BGB)), the contract contains an obligation to sell a parcel of land and to construct or renovate a building on it in accordance with the agreement—a combined contract involving multiple obligations.

Sample Contract for Work and Services

Conclusion – Legal Aspects of Contracts for Work and Services

• A contract for work and services is intended to produce a specific result. The obligation is to deliver the result of the work, not merely to perform the work itself. The result may be tangible (construction of a building) or intangible (creation of a website).
• Once the work has been completed, it must be accepted by the client. The client may refuse acceptance if there is a material defect. Several minor defects may, when taken together, also constitute a material defect.
• If the customer has refused acceptance, he may rescind the contract, demand subsequent performance, or reduce the agreed-upon price for the work.
• If a contract for services is concluded with a consumer via means of distance communication, the consumer must be informed of the 14-day right of withdrawal. If work begins before this period expires, the client’s written consent should be obtained.
• The cost estimate is generally provided free of charge. If the costs significantly exceed the agreed amount, the client may withdraw from the contract or bear the higher costs.
• Payment for the work is due upon successful acceptance. If defects remain, the client may withhold twice the estimated cost of rectifying the defects (printing surcharge).