Abstract: The blog post explains the difference between service and works contract and what this means for a service contract. It is emphasized that the distinction between the two types of contract is particularly relevant for the delimitation of remuneration claims and liability issues.
In my BLOG 5, I discussed different partner models on a T&M basis (billing based on time and effort). As far as the legal form of the contract is concerned, both as a representative of the user side (client) and as the responsible IT service provider (contractor), I have only ever had and followed discussions over the past two decades about whether we wanted to strive for and conclude a service provision contract or a works contract. This was essentially always based on the question of whether we should agree on a fixed-price contract (works contract; usually with milestone invoicing) or one based on time and effort (service provision contract; usually with monthly invoicing of the confirmed activity reports at the agreed hourly rate).
Furthermore, it was generally accepted that in the case of a works contract (fixed price), a risk surcharge could be made because, on the one hand, the service provider had to estimate the expenses for determining the fixed price in advance and, on the other hand, also had to bear any error corrections and related costs himself. In a service provision contract, on the other hand, it was tacitly assumed that all expenses could be invoiced, regardless of whether they were caused by the request or by the service provider’s own inability to correct errors.
It is true that the distinction between a contract for services and a works contract – as well as some other more precise regulations – is generally observed primarily in the DACH region. However, the concept is in principle also not foreign in the rest of Europe, in the USA or, for example, in Japan. Accordingly, subsequent references to laws or court rulings are based on case law in Germany.
Over the course of the past year, I had the privilege of working with Dr. Christian Förster, a very accomplished attorney specializing in IT law, to clarify several contractual situations as the user’s representative with various IT service providers.
The first and most important insight for me was: There is no such thing as a service provision contract in statutory law [= Gesetzesrecht]!
In order to clearly determine the performance owed by the service provider, one must rather decide between a service contract and a works contract:
- in the case of the service contract (§§ 611 ff. BGB), only a contractually specified performance is owed, which may be “services of any kind”. Liability for deficiencies in the service is governed by general law on disturbance of performance (§§ 280 ff. BGB), so that, for example, damages may be claimed for poor performance in terms of substance (deficiency) or time (delay).
Generally speaking: Under a service contract, the contractor owes the client only the time and effort to complete a task assigned to him to the best of his ability. The best example of a service contract is the employment relationship between employer and employee – here the employee owes the employer e.g. 35 hrs per week and is paid if he was present accordingly and made an effort to complete the tasks assigned to him. Whether and how well this has worked and ergo the results are, plays a subordinate role.
In contrast, in the case of a works contract (§§ 631 ff. BGB), a “work” is to be produced, i.e. a contractually defined “success” is owed. The law on contracts for work and services therefore also provides for successful acceptance as a prerequisite for the contractor’s claim to remuneration (§§ 640, 641 BGB). The warranty for defects is regulated independently and similarly to the purchase contract (§§ 633 ff. BGB); it provides for supplementary performance (repair or new production), substitute performance by the customer (= client) after unsuccessful setting of a deadline as well as reduction as special remedies. Any claims for damages, however, are again governed by the general law on disruptions to performance as in the case of the service contract.
Generally speaking: Within the framework of a works contract, the contractor owes the client success, i.e. the successful result of his work. Thereby it is implicitly essential that the following aspects are specified: the result to be produced, the criteria for acceptance, the acceptance process and the consequences of an unsuccessful acceptance (corrective measures).
It is often the case that the total trade agreed in a works contract is made up of the successful delivery of several smaller trades, and the partial results and acceptance criteria are defined per trade, while the acceptance process and corrective actions can be defined uniformly for all trades.
However, it is essential that the contractor’s claim to remuneration only arises after the customer has accepted the work.
Since service contracts as such do not legally exist, contractors largely assume that their orders are service contracts, i.e. that they can charge for the time spent regardless of the results of the work. In contrast, clients assume that they will be delivered agreed results, even if these are not detailed and accompanied by acceptance criteria.
But what are service contracts in the context of SAP implementations all about?
The creation of software, which includes the adaptation (also so-called “customizing”) and implementation of standard software, has always been classified as a works contract by case law and literature. In the case of standard software, the main focus was and still is on the distinction from the purchase contract; the service contract plays practically no role here.
The BGH has repeatedly confirmed this classification (first BGH BeckRS 1971, 31011275; later for example BGHZ 102, 135 = NJW 1988, 406), from more recent times see for example:
- The contractual agreement of July 28, 2004, designated as a “service provision contract for a P software system” was correctly qualified as a works contract. The subject matter of this contract was an extensive adaptation of the defendant’s P software to the needs of the plaintiff and the creation of interfaces to CWL. (BGH NJW 2010, 2200 marginal no. 14)
- The contract of the parties [was] correctly classified as a works contract. The subject of the contract was the adaptation of the defendant’s software to the needs of the plaintiff and the creation of interfaces to the online stores. Thus, the defendant owed the achievement of the contractually agreed success as the result of an individual activity for the plaintiff (BGH NJW-RR 2014, 1204 marginal no. 13).
Unless explicitly agreed otherwise, service contracts are therefore to be classified as contracts for work and services. This means that at least the following aspects should be settled by mutual agreement before the contract is concluded:
- the result to be created
- the criteria for acceptance
- the acceptance process
- the consequences of unsuccessful acceptance (corrective measures within the scope of subsequent performance)
In addition, I recommend that the following also be mutually agreed upon:
- a RACI matrix that regulates cooperation (at least at the level of the individual trades). In this context, I have also found it useful to provide these with the respective planned completion dates – this gives planning security for all parties.
- a definition of fault and malfunction categories
- Service levels and response times – at least for acceptance and fault elimination
Furthermore, you should take into account that all of this by no means simultaneously means that billing can only take place in the form of fixed prices. The services can also be invoiced according to T&M (time and effort) (see also BLOG 5). However, it is essential that the contractor’s entitlement to remuneration only exists after acceptance of the trades justifying the services. One regulation could read:
“After successful acceptance, monthly invoices may be issued for the documented and approved efforts for the partial deliverables completed during the month – the appropriate acceptance forms and approved time sheets shall be attached to the invoice.”
In my perception, there is a great backlog demand to adapting IT service contracts in companies. Legal conformity and legal certainty is an essential basis for reducing conflict potential for the future and being able to deal with each other in a cooperative, transparent and fair manner.
We would be happy to offer you our support upon request ). Together with Dr. Förster, partner at Bartsch Rechtsanwälte in Karlsruhe (), we will accompany you in the creation/finalization of new contracts with your IT service providers and will also gladly take over the review of existing contracts, point out the deficits and existing legal uncertainties and make concrete suggestions on how to eliminate them. Ideally, such an engagement will lead to a corresponding understanding of these specific issues on the part of your responsible purchasers. In the future, they should be able to avoid legal deficits to your disadvantage in future contract negotiations from the outset, independently and on the basis of a checklist we draw up for them.
Please feel free to contact us and get a first impression of what we could achieve for you by combining our competences and experience in a joint meeting with Dr. Förster and myself, Christian Schütte.
Whether and to what extent documentation for the add-ons provided by the contractor as well as for additionally created individual developments, configurations or customizations has to be created and delivered (as an integral part of the work performed) by the contractor, I will discuss with you in the upcoming blog post 32. I look forward to you visiting my blog again soon!