What is the extent of outsourcing in your jurisdiction, including the most common sectors for outsourcing activities?
Outsourcing is common in Germany and affects all industry sectors. The extent of outsourcing significantly differs between companies. Some companies, especially small and medium-sized companies, are likely to engage external suppliers only with regard to distinct services (eg, certain cloud-based services to replace former on-premise solutions), rather than outsourcing complete business processes. Companies with a strong focus on one line of products or services often outsource parts of their business (eg, IT, logistics, procurement, HR and customer and call centre relations) that, while necessary, fulfil only ancillary functions. By doing so, they can free up resources and dedicate them to their core business while ensuring state-of-the-art services in an area that they do not focus on.
How would you describe the government’s approach to outsourcing arrangements? Are there any government-sponsored incentives for outsourcing, or restrictions on outsourcing abroad?
The government has no particular approach to outsourcing, nor are there any government-sponsored incentives for outsourcing. Outsourcing is subject to the general laws and regulations. As such, general restrictions on providing services abroad also apply to outsourcing. For example, pursuant to applicable tax laws in Germany, recordkeeping abroad is allowed only under limited circumstances. Similarly, any transfer of personal data in an outsourcing context is subject to applicable data protection laws – in particular, the requirement to ensure an adequate level of data protection where personal data is transferred to a country outside the European Union or European Economic Area.
Is there any overarching domestic legislation governing outsourcing?
In Germany no overarching domestic legislation specifically governs outsourcing. However, there are many laws that, without specifically relating to outsourcing, apply to outsourcing activities. For example, relevant laws to be considered in an outsourcing context include employments laws (eg, employment protection legislation, minimum wage laws, laws regulating freelancing and body leasing, as well as co-determination rights of the works council), copyright laws, data protection and data security provisions. Such laws can apply to the supplier either directly (eg, telecoms laws if the supplier provides such services) or indirectly (eg, where the supplier is subjected to specific requirements because the customer is engaged in a regulated industry and passes on the specific requirements).
Are there any sector-specific laws or industry guidelines on outsourcing?
Yes, there are some sector-specific laws and industry guidelines on outsourcing. For example, Section 25b of the Banking Act, as supplemented by the Minimum Requirements for Risk Management published by the Federal Financial Supervisory Authority, sets out certain requirements for outsourcing services in the banking sector, including contractual provisions to be agreed in the outsourcing contract. Similarly, Section 32 of the Insurance Supervision Act sets out certain requirements for outsourcing by insurers.
Licences, permits and approvals
What licences, permits and/or approvals are required for outsourcing activities, if any? What are the penalties for non-compliance with these requirements?
No licences, permits or approval requirements directly relate to outsourcing. However, general licences, permits and approval requirements may apply to outsourcing activities. For example, if the customer contributes software, it will be necessary to evaluate whether the licence terms allow the supplier to use the software. Failure to ensure all necessary use rights are in place may lead to cease and desist and/or damage claims.
A permit is required where outsourcing affects electronic recordkeeping abroad or involves body leasing. Unauthorised body leasing constitutes an administrative offence for both the lender and the lessee and is subject to administrative fines of up to €30,000.
Further, it may be necessary to engage the works council prior to the outsourcing (eg, where the outsourcing leads to a transfer of employees or undertakings).
Where outsourcing involves the processing of personal data and, following a data protection impact assessment, such processing is likely to result in a high risk to the rights and freedoms of natural persons if the controller fails to take measures to mitigate the risk, the controller must consult the supervisory authority prior to the processing. Infringements of this requirement are subject to administrative fines of up to €10 million, or in the case of an undertaking, of up to 2% of the total worldwide annual turnover of the preceding financial year, whichever is higher.
Are any legislative or regulatory reforms envisaged or underway which will affect outsourcing arrangements?
Yes, a regulatory reform affecting outsourcing is underway in the banking sector. The European Banking Authority recently published draft guidelines on outsourcing arrangements that will impose requirements on banks and financial institutions intending to outsource certain functions that go beyond the existing requirements of the Banking Act and the Minimum Requirements for Risk Management published by the Federal Financial Supervisory Authority. These guidelines will apply from 30 June 2019.
With regard to data processing in the context of outsourcing, it remains to be seen whether the existing available measures to provide adequate safeguards for the transfer of personal data to a country outside the European Union or European Economic Area will remain effective. In particular, it is unclear whether so-called ‘standard contractual clauses’ will remain a valid basis for such transfers. The validity of the respective EU Commission decisions is currently the subject matter of a proceeding for preliminary ruling before the Court of Justice of the European Union.
As regards data transfers to the United States, it remains to be seen whether the EU-US Privacy Shield will remain a means of ensuring an adequate level of data protection for data transfers to the US. The Privacy Shield is subject to an annual review by the EU Commission. In its second annual review, the European Commission required that a permanent privacy shield ombudsperson be appointed as a matter of priority and reserved the right to take appropriate measures under the General Data Protection Regulation should this not be achieved by 28 February 2019.
Further, there has recently been a change in the Criminal Act and related statutes affecting outsourcing by persons subject to professional secrecy (eg, physicians, accountants, auditors and lawyers). According to the change in law, persons subject to professional secrecy may engage with, and thereby disclose professional secrets to, suppliers without violating their secrecy obligations if the disclosure is limited to the extent necessary for the receipt of the services. However, persons subject to professional secrecy must impose confidentiality obligations on the supplier; otherwise, they can be punished under criminal law if the supplier discloses the secret without authorisation.
What legal vehicles/structures are available for outsourcing arrangements, and what are the advantages and disadvantages of each?
All legal vehicles or structures are generally available for outsourcing arrangements. Sometimes outsourcing results in a company restructuring or the incorporation of a new legal entity. This is often the case where groups of companies outsource services and, instead of choosing an external supplier, establish separate legal entities as group internal service centres for different business areas (eg, IT, logistics, procurement, HR or customer and call centre relations). Outsourcing also takes place in the form of joint ventures. This is especially the case in the public sector, where public-private partnership are often formed.
What are the most common contract forms for outsourcing arrangements, and what are the advantages and disadvantages of each?
The parties to an outsourcing agreement usually enter into a master services agreement, consisting of the main body of the agreement and a number of schedules and exhibits dealing with the specifics of the agreement (eg, transition, transformation, service levels, governance, pricing, penalties, exit management, data protection and IT security).
Often, outsourcing agreements concern not only a main customer and main supplier, but also several legal entities in several jurisdictions (ie, affiliates of the customer or the supplier in other affected jurisdictions). In such cases, the entities in the other jurisdictions usually enter into local services agreements referring to the master service agreement and localising it to the extent required or useful under local law (eg, with regard to local tax law, employment law, data protection or data security requirements).
Before entering into an outsourcing contract, what due diligence is advised?
During the selection process, customers should ensure that the supplier has appropriate and sufficient ability, capacity and resources to perform the outsourced function. To this end, customers should also consider potential critical events that may arise during the contract and the supplier’s ability to ensure business continuity, especially where business critical functions are being outsourced.
Additional factors to be considered during due diligence include the supplier’s:
- experience with similar outsourcing projects and its reputation with customers;
- financial situation; and
- group structure (along with whether it would be possible to obtain parental guarantees for the provision of services).
The supplier's exit management approach is often overlooked at the onset of an outsourcing project. However, professional conduct at the end of a project and assistance with the transfer of services to a succeeding supplier or the customer itself is important for business continuity.
- Where outsourcing involves the processing of personal data by the supplier on the customer’s behalf, the General Data Protection Regulation (GDPR) requires that customers use suppliers that provide sufficient guarantees to implement appropriate technical and organisational measures in such a manner that processing will meet the requirements of the GDPR and ensure the protection of the rights of the data subject.
Customers typically set no lower requirements when outsourcing concerns confidential business information rather than personal data.
To protect and enforce their own social responsibility standards, customers should also consider their codes of conduct and verify that the supplier (and its subcontractors) respect internationally recognised human rights standards, environmental protection and appropriate working conditions, especially where the supplier (or a subcontractor) is located in a third country.
Duration and renewal
What is the common duration of outsourcing contracts? How does the renewal process commonly play out?
Outsourcing contracts usually run for extended periods. A five to 10-year term is not uncommon. However, customers usually try to retain flexibility with regard to:
- contract termination
- the right to transfer services to a new supplier; and
- the right to transfer services back to the customer.
On the other hand, suppliers usually face high costs at the beginning of an outsourcing project and start to make profits only later on during the project. Therefore, suppliers usually try to agree on a minimum term during which the contract cannot be terminated for convenience. A minimum term between one and five years is common, depending on the complexity of the project. Thereafter, the contract usually provides for an automatic prolongation at specific intervals.
The customer’s termination rights sometimes differ from the supplier’s, providing the customer with more flexibility to terminate the contract while restricting the supplier’s termination rights (eg, the supplier will have a longer notice period to give the customer more time to prepare for the next generation of outsourcing or the resumption of in-house services).
What procedures and criteria are commonly used to select suppliers?
Suppliers are typically selected in a request for proposal procedure. That is, the customer submits a request for proposal, sometimes following a prior request for information (ie, a procedure designed to provide a customer entering a new field of business or unaccustomed activity with an understanding on the range of options), to different suppliers, asking them to provide an offer for the requested services. Before the request for proposal documents are provided to the suppliers, they must usually sign a non-disclosure agreement. Once the proposals are submitted and evaluated by the customer, several suppliers will be shortlisted and invited to a Q&A session or due diligence where they can present their proposals in person and clarify any questions therein.
After these meetings, suppliers usually update their proposal (ie, specify their offers on the basis of clarified assumptions during the Q&A sessions or due diligence). Further rounds of commercial and legal negotiations may follow, ending with the submission of the suppliers’ best and final offers and the customer accepting one.
With regard to public procurement procedures, negotiations are uncommon, as public procurement rules allow negotiations only under limited circumstances. Suppliers must usually submit a binding offer directly to the public customer, which will consider certain selection criteria before accepting.
How are the service specifications agreed and monitored, and what service terms and parameters are commonly applied? Can any flexibility be provided for in these terms?
Service specifications are agreed in service schedules or exhibits to the outsourcing contract laying out the details of the desired solution. Service levels and/or key performance indicators (KPIs) are usually agreed to define and measure the supplier's performance of the agreed services. The service level regime is often accompanied by penalty provisions and service level credits. Service levels must be measurable and suppliers are usually obligated to regularly report on compliance with agreed service levels. Suppliers usually focus on carve-outs from service-level requirements where failure to meet service levels is not attributable to them (eg, because of non-cooperation by the customer or a force majeure event). To provide flexibility on the terms, outsourcing contracts often contain clauses that service levels or KPIs can be exchanged or removed and new service levels or KPIs be added to the contract. Flexibility with regard to service-level credits may be agreed by way of an earn-back mechanism, giving the supplier the chance to remedy failure to meet a specific service level in one month by overachieving in another month or obtaining service bonuses if service levels are exceeded.
What charging methods are commonly used?
Charging can generally be either on a fixed-price or time and material (T&M) basis. In outsourcing agreements, many different remuneration models are used and outsourcing agreements often contain a mixture of fixed-price and T&M paid elements. This is because outsourcing agreements often consist of different service components that can be assigned separate price tags (eg, any software or hardware procured by the supplier will usually be charged at their standard fixed prices).
On the other hand, different service elements (eg, transition, transformation, run, developments and smaller enhancements) can either be assigned a separate (fixed) price or be remunerated on a T&M basis. It is also common to use a fixed remuneration based on certain pre-defined parameters (eg, in relation to software support services, the number of service requests or tickets and their complexity).
Warranties and indemnities
What warranties and indemnities are commonly stipulated in outsourcing contracts (for both the customer and the supplier)? Are there any mandatory or prohibited provisions in this regard?
The warranties applicable in outsourcing contracts depend on the nature of the services provided.
Under German statutory law, some parts of outsourcing contracts (eg, the provision of software or hardware on a permanent basis) are generally subject to the statutory warranty regime applicable to purchase contracts. Further, customer-specific software developments are typically subject to the statutory warranty regime applicable to contracts for work performances. Software as a service/ cloud services are generally regarded by the German courts as a software lease and thus subject to the warranty regime for leases. However, parties frequently deviate from the statutory warranty regime by way of individual agreements and, for example, substitute statutory warranties with specific support and maintenance obligations and service-level agreements.
IP indemnities for violations of third-party rights are frequently applied in outsourcing contracts. With regard to the increased liability risks for data protection violations under the General Data Protection Regulation, customers often request indemnity for data protection breaches; however, suppliers regularly reject such requests. While suppliers provide most of the indemnities, these may also be mutually applicable. This is often the case where the customer contributes certain software and indemnifies the supplier from any third-party claims relating to the supplier's use of such software during the outsourcing contract.
Ending the agreement
What are acceptable grounds for terminating an outsourcing contract?
Outsourcing contracts typically provide for ordinary termination rights of either party – that is, the right to terminate the contract for convenience by giving specific prior notice (after expiry of the mutually agreed minimum period).
However, it is not uncommon for the customer and supplier’s termination rights to differ. In such cases, the customer typically has more flexibility to terminate the contract, while the supplier has limited termination rights (eg, the supplier usually has longer notice periods to give the customer more time to prepare for the next generation outsourcing or in-house service resumption).
In addition, each party has the right to terminate the outsourcing contract with immediate effect for good cause. Specific reasons for such extraordinary termination may be defined in the contract. Where good cause consists of a contractual breach, the other party must generally be provided with a prior warning before it can terminate the agreement.
How do contracts commonly address exit from the outsourcing contract?
Contracts commonly address exit from the outsourcing contract in an exit management schedule, which typically include rules on:
- providing termination assistance and knowledge transfers to the customer and/or a succeeding supplier;
- transferring data and third-party contracts; and
- cooperating with the new supplier (where applicable).
Where the incumbent uses specific software or delivery tools to provide the service, customers sometimes also include provisions for the transfer of such software and tools at the end of the contract.
On the other hand, suppliers will include provisions protecting their intellectual property and clearly defining the terms for any transfer of software or tools at the end of the contract. Outsourcing contracts often provide for termination assistance also after expiry of the contract, during which time the terms of the contract (including respective service-level agreements) will continue to apply. However, this can:
- interfere with the supplier’s internal plans to allocate resources after the scheduled end of a project; and
- affect the supplier’s calculation and risk assessment of the project.
When entering into a contract, exit management strategy is not always given the attention that it deserves. It is paramount to consider exit strategies carefully when setting up a contract, as the chance to reach a mutually beneficial agreement on the aforementioned issues significantly decreases after termination.
Is there a common or mandatory notice period for non-renewal of a contract?
No, there is no common or mandatory notice period for non-renewal of a contract. Usually, termination periods span between three months and one year (with potentially different periods applying to the customer and supplier).
What can customers do to make their outsourcing contract more successful?
Customers should have a clear outsourcing strategy and evaluate the benefits of outsourcing services carefully before entering into an outsourcing project. This includes considering:
- next generation outsourcing or the possibility of the customer resuming the outsourced services at the end of the contract; and
- the required exit management strategy and knowledge transfer.
Internal stakeholders should be involved early in the process, as should the interests of affected employees and works councils.
With regard to the outsourcing contract, it is paramount to clearly describe the service requirements and avoid any ambiguity in the service description and definition of corresponding customer contributions. Otherwise, it is likely that disputes concerning the respective responsibilities will arise. Further, a clear project governance and escalation procedure should be set up, ensuring that decisions are made promptly and conflicts resolved at an early stage so as not to hinder the project’s progress.
Remedies and protections
What legal remedies are available to the parties to an outsourcing contract in the event of contractual breach or unjust termination?
In the event of a contractual breach or unjust termination, the other party can bring a claim for proper performance of the contract and/or claim damages. Further, the affected party may be entitled to terminate the outsourcing contract for good cause. In the event of unjust termination of the contract by one party, the other party can also bring a declaratory action to clarify that the contract has not been effectually terminated and is still in effect. If time is of the essence, a party can also seek a preliminary injunction.
What other remedies are available (eg, contractual)?
Outsourcing contracts frequently set out contractual penalties or service credits for certain breaches of contractual obligations (eg, delays in the provision of services).
How can the parties to an outsourcing agreement limit or exclude their liability?
German law provides some flexibility to exclude or limit liability by way of a mutual agreement between the parties, whereas liability in case of intent cannot be excluded in advance. However, possibilities to exclude or limit liability in standard business terms (ie, in terms that are posed by one party without being individually negotiated) are extremely limited under the German law on standard business terms. For example, it is not possible to limit or exclude liability for gross negligence, or for damage to life, limb or health, where a party has assumed a guarantee, or where the law requires unlimited liability (eg, under the German Product Liability Act) in standard business terms. The possibility of excluding or limiting liability in cases of slight negligence in standard business terms is also limited. For example, a party’s liability for essential contractual obligations cannot be excluded. Invalid liability clauses will be unenforceable and replaced by the (unlimited) liability foreseen by German law. Thus, it is generally advisable to individually negotiate and agree on a mutually acceptable liability clauses in outsourcing agreements which will not be subject to the strict requirements of the German law on standard business terms.
Asset transfer and assignment
Movable and immovable property
What rules, standards and procedures govern the transfer and assignment of movable and immovable property in the context of an outsourcing arrangement?
Generally, the same rules, standards and procedures (eg, notarial certification requirements for the transfer of immovable property) govern the transfer and assignment of movable and immovable property in the context of an outsourcing arrangement as in other contexts where movable and immovable property will be transferred or assigned.
What rules, standards and procedures govern the transfer and assignment of intellectual property in the context of an outsourcing arrangement?
Generally, the same rules, standards and procedures govern the transfer and assignment of intellectual property in the context of an outsourcing arrangement as in other contexts where IP rights will be transferred or assigned.
However, some specific questions regularly arise in an outsourcing context. For example, where the customer owns software that will be used by the supplier for outsourcing services, it will probably licence the software to the supplier for the term of the outsourcing contract as part of its cooperation obligations. However, where the customer only licences software from a third party, it must be assessed whether the licence terms agreed between the customer and the third party allow the supplier to use the software for its outsourced services.
On the other hand, where the supplier owns software that will be used for the purposes of the outsourced services, the customer’s use rights must be agreed – in particular, whether:
- the licence will be limited to the term of the outsourcing contract or also apply thereafter; and
- the customer will be allowed to transfer or sub-licence the software to third parties, including a subsequent supplier.
How can a customer’s rights and obligations under another contract be transferred/assigned to the supplier?
A customer may transfer or assign another contract, or individual obligations thereunder, to the supplier only with the other party’s consent (ie, the other party must agree to its new contractual counterparty). However, individual customer claims can generally be assigned to a third party (eg, a supplier) unless the contract includes deviating provisions (to the extent that they can be validly agreed).
What rules, standards and procedures govern the protection and transfer of data in the context of an outsourcing arrangement? Are there any sector-specific regulations in this regard? What are the penalties for non-compliance?
The protection and transfer of personal data in the context of an outsourcing arrangement is governed by the EU General Data Protection Regulation (GDPR) and (on the basis of opening clauses in the GDPR) the German Federal Data Protection Act (not considering additional state-level data protection acts and individual provisions governing data protection in special laws), both of which apply since 25 May 2018.
In particular, customers engaging suppliers to process personal data on their behalf must enter into a data processing agreement pursuant to Article 28 of the GDPR with the supplier. Further, the customer must assess the adequacy of the supplier's technical and organisational measures prior to the engagement and regularly during the service provision. If the supplier is located in a country outside the European Union or European Economic Area, the customer must also ensure adequate protection of the personal data in such country.
To this end, the EU Commission has recognised some countries as providing an adequate level of data protection. For other countries, protection can be provided by, for example:
- concluding so-called ‘standard contractual clauses’ (controller to processor);
- using binding corporate rules (applicable for only group internal data transfers); or
- applying the EU-US Privacy Shield (applicable only for transfers from the European Union to the United States).
In the case of non-compliance with data protection laws, the customer and supplier can be held jointly liable. Penalties for non-compliance may amount to up to €20 million or, in the case of an undertaking, up to 4% of the total worldwide annual turnover of the preceding financial year, whichever is higher. In addition, the Federal Data Protection Act provides for criminal penalties for certain violations of data protection obligations. Special regard should be taken if an outsourcing agreement affects data that is subject to professional secrecy (eg, information entrusted to a physician in connection with a medical treatment), as the disclosure of a professional secret constitutes a criminal offence, punishable by imprisonment or a monetary fine. However, pursuant to a recent change of German criminal law, outsourcing concerning data subject to professional secrecy is allowed if special confidentiality requirements are observed.
Employment and labour
What rules, obligations and liabilities apply to the transfer of employees to and from the customer and supplier (including with regard to offshoring arrangements and termination of the outsourcing contract)?
An outsourcing arrangement constitutes a transfer of business (ie, a transfer of the business' employees) if:
- the outsourced function forms a separate identifiable business unit (or part thereof) within the customer’s organisation or the company which offshores certain services (the transferor) with an inner-organisational structure; and
- the supplier or the offshore entity (the transferee) assumes a certain amount of assets and/or personnel associated with the outsourced function.
Relevant assets not only include tangible assets (eg, real estate, production and office facilities, equipment and inventory), but also customer contracts, a customer data base, IP rights, know-how and other intangible assets.
A case-by-case assessment is required for each potential transfer. If an outsourcing contract is terminated, a transfer of business could also occur from the initial transferee to the transferor or a successor supplier.
In the case of a transfer of business, the employment contracts of employees employed by transferor in the business unit (or part thereof) automatically transfer to transferee on their existing terms. All of the transferor's rights, powers, duties and liabilities under, or in connection with, the transferring employees’ contracts pass to the transferee and any acts or omissions by the transferor before the transfer are treated as having been done by the transferee.
The transferor and transferee are jointly liable for obligations towards the transferring employees, provided that:
- these obligations existed prior to the effective transfer date; and
- they become due either prior to or within a 12-month period following the effective transfer date.
For the latter obligations, the transferor is liable for a pro rata amount of the obligations, calculated by the portion of obligations due to employees based on their length of service prior to the transfer. Exceptions apply to social security contributions and pension rights.
Affected employees of the transferor have the right to object to the transfer to the transferee. Objections can only be raised in writing within a period of one month after the employees have been notified of the transfer of business. If the transferor of the transferee fails to comply with statutory requirements regarding the form and the contents of the notification, affected employees have, in principle, an unlimited right to object to the transfer. If the employees do object, the employment relationship with the transferor will remain in existence.
Definition of ‘employer’
How is ‘employer’ defined in the context of an outsourcing arrangement, and how does this affect the parties’ responsibilities and liabilities?
The 'employer' is defined as the company in which business organisation an individual is integrated and from which the individual receives instructions regarding working time, place of work and details of work.
In outsourcing arrangements, it is essential to determine which entity is the employer. In particular, if an arrangement is a service agreement between two entities, the factual employer can be decisive for inadvertent labour lease (eg, if the employees are fully managed by and integrated into the customer's business organisation). Non-compliance with the strict regulations on labour lease can lead to:
- employee claims that they became the customer’s employees;
- administrative fines; and
- secondary liability on the part of the customer for wage tax and social security contributions.
In order to avoid inadvertent labour lease, the service contract should be carefully drafted and the supplier’s employees should receive instructions only from the supplier.
Organised labour issues
To what extent are labour unions and works councils involved in outsourcing arrangements?
If the outsourcing arrangement constitutes a transfer of business, co-determination rights of the works council, if any, are triggered if:
- parts of the business are transferred and therefore the business is split; or
- the transfer is accompanied by substantial reorganisation measures or substantial redundancies.
In such cases, an equalisation of interest agreement and social plan must be negotiated with the works council prior to implementation.
If the transfer of business involves a larger business, the business' economic committee, an intra-company body consisting mostly of works council members, must be informed about the business transfer.
In exceptional cases, the works council must consent to the provision of services by the supplier on the customer’s worksite.
What immigration schemes and rules are pertinent in the context of outsourcing arrangements?
If the outsourcing arrangement constitutes a transfer of business and a non-EU citizen holds the required residence permit with work authorisation for a specific company only, the competent immigration office must give its consent to the change of employer prior to the transfer.
If the outsourcing arrangement is a service agreement and the work authorisation is limited to a specific company, the individual must remain the supplier’s employee. For this purpose, the individual should be integrated into the supplier's business and receive instructions regarding working time, place of work and details of work by the supplier only.
What tax liabilities arise in the context of an outsourcing arrangement? Can these be mitigated in any way?
Tax on services under outsourcing agreements In Germany, apart from value added tax (VAT), no stamp duty or transfer tax is basically imposed on rendering IT services. The service recipient may mitigate the VAT burden if it is entitled to input VAT deduction. If a non-German service provider provides the outsourcing services, these will be assessed to determine whether they qualify as software as a service, an application service or as another service, which can under certain circumstances trigger withholding tax if they qualify as the granting of a licence. If this applies, the customer need not levy withholding tax, provided that an exemption certificate is available when the service is paid for.
Tax on transfer of assets or intangibles under outsourcing agreements In the context of an outsourcing arrangement, several tax liabilities (eg, (corporate) income tax, trade tax, VAT and real estate transfer tax) can arise if the conclusion of the outsourcing agreement leads to a sale or other form of asset transfer. The tax liabilities depend on the structuring of the outsourcing transaction and, in particular, if and what assets are transferred. Under certain circumstances, the transferee may become secondarily liable for certain taxes of the transferor. Such secondary liability can be addressed by an indemnification clause, but statutory secondary liability cannot be suspended.
Further, a cross-border IT outsourcing transaction must be carefully planned to avoid creating an undesired permanent establishment. In relation to intra-group outsourcing transactions, the transfer pricing rules must be considered and sufficient documentation in this respect must be prepared.
Common disputes and resolution forms
What are the most common types of dispute arising from an outsourcing agreement and how are they typically resolved? Is alternative dispute resolution (ADR) common and effective?
Outsourcing contracts are long-term contracts with an initial short transition and transformation phase in which the provider takes over the IT infrastructure and a second, long phase in which the provider actually runs the services (steady state).
The most common disputes are set out below.
Transition and transformation phase Most disputes arise from difficulties during the transition and transformation phase. This phase is not only technically challenging, but also subject to tight milestones. Therefore, delays regularly occur or the provider fails to meet agreed technical specifications. This results in damages or penalties. In a worst-case scenario, the contract will be terminated for cause. This typically triggers high damages for non-performance.
In order to counter these issues, the following measures are recommended:
- agree on realistic timelines;
- agree on feasible specifications; and
- include strict limitations of liability for the transition and transformation phase (eg, a hard cap on the remuneration for this phase).
Steady state phase During this phase (ie, when services are actually provided), claims mainly arise from the breach of agreed service levels. This usually triggers agreed penalties. A termination for cause is usually unlikely because the customer would have to provide the complete infrastructure to a new provider.
In order to counter these issues, the following measures are recommended:
- establish efficient project management policies;
- create a clear penalty regime with detailed specifications in the service-level agreements; and
- introduce limitations of liability.
Dispute resolution by litigation Disputes are typically resolved through court litigation. However, state court judges often lack special knowledge to handle the technical complexity of an outsourcing dispute. Therefore, parties should consider arbitration or using the conciliation services of institutions like the German Association of Law and Informatics.
Recent case law
Has there been any notable recent case law which may affect the resolution of outsourcing disputes in future?
There has been no recent single court decision relating to outsourcing contracts worth mentioning.