The importance of cash flow in projects is rather straightforward and best summed up with the old saying “revenue is vanity, cash flow is sanity and cash is reality.” The consequences of contractors and sub-contractors failing to have a proper cash flow are rather obvious, financial stress being most likely followed by insolvency. This appears to be a serious issue in England and Wales with various reports and studies released on payment and cash flow (Latham Report: “Constructing the Team” (1994) and Egan Report “Rethinking Construction: Achievements, Next Steps and Getting Involved” (2002)). One need only examine the empirical data contained in these reports to ascertain the delicate situation of contractors and sub-contractors and the need for a practical system for protecting payment and hence, cash flow.
The problems with payment and cash flow are not endemic only to England and Wales or confined to the construction industry, even at the EU level efforts have been made to address parts of this issue with the EU Late Payment Directive (Directive 2011/7/EU). The directive was designed to help small and medium enterprises to allow better management of their cash flow (larger companies were accused of stringing out trade payment to smaller companies beyond reasonable terms). Not all countries immediately pressed forward in implementing the directive, with Germany notably being the last. There has been much criticism whether the directive will be practically positive given that many of the directive’s beneficiaries (in particular sub-contractors) are cautious to follow the enforcement mechanism for fear of being considered “difficult” or having too much “red tape” and thus losing work to competitors who are less stringent with payment. In any event, a laudable effort by the EU is to partially assist in improving a very real and perennial problem faced by trade contractors (or sub-contractors) in the construction industry.
Having touched on England and Wales (and Europe at large), where does Germany stand on the issues of cash flow and payment? The security of payment in construction was an issue German legislators first addressed at the beginning of the 20th century – incredibly progressive considering this was almost 100 years earlier in comparison to Common law jurisdictions such as England or Australia (1996 and 1999, respectively). The German “Construction Payments Security Act,” adopted in 1909, was the first step in securing payment for contractors or sub-contractors (this introduced the concept “Baugeld” (construction money), payment amounts earmarked for the cost of a construction project). In the 1990s there were growing calls to help contractors enforce payment claims against employers because at that time, under the German Civil Code, the employer was not required to make any payment(s) to the contractor until taking-over (completion) of the works (unless otherwise agreed by parties). This effectively stifled cash flow in construction and insolvency was a very real consequence contractors faced whilst waiting for taking-over. Thus changes to the German law were introduced in 2000 relating to “cash flow” where contractors were able to demand progress payments, even if taking-over (completion) had not occurred (“Gesetz zur Beschleunigung fälliger Zahlungen“ (Late Payment of Commercial Debts Act), 30.03.2000). Despite these seemingly radical changes, further amendments were made in 2008 with the “Forderungssicherungsgesetz” (“Enforcement of Payment Act”). There were a number of changes made to improve “cash flow” to contractors and sub-contractors. These included:
(1) Improvements to the changes in 2000 on allowing contractors and sub-contractor to request progress payments;
(2) Improvements to the legislative provision for securing payment under the German Civil Code § 648(a); and
(3) Directors of the contractor companies were personally liable to the sub-contractors for failing to pay the Baugeld.
Under Common law a bond is a deed by which one person, the bondsman, the “surety”, (often called the “obligor” or “bondsman”) binds himself to another (often called the “obligee” or “creditor”) for payment of a specified amount at some future date or upon the happening of some particular event. The liability for the bondsman to pay will generally be based on a material breach of an underlying contract. There are essentially two types of bonds, on-demand and conditional, the key difference being conditional bonds are predicated on a breach of an underlying contract, whereas an on-demand bond will be paid by the bondsman “on-demand” without further conditions.
The distinction between bonds and guarantee, and conditional and on-demand bonds, under German law may appear confusing to English lawyers as one cannot compartmentalize legal principles between the two jurisdictions. Thus, examples will be used at times to assist in understanding the German law position. Firstly, the legal principle of “surety” is not foreign to German law and surety in the form of bonds can best be described as a “Bürgschaft.” The different types of Bürgschaft (bonds) typically found in England are also found in Germany, these being:
- Bid bond/tender bond – this is not particularly common under the German system;
- Advance payment bond – “Vorauszahlungsbürgschaft;”
- Performance bond – “Vertragserfüllungsbürgschaft;”
- Payment bond – “Zahlungsbürgschaft;” and
- Defects liability period – “Gewährleistungsbürgschaft.”
Under a Bürgschaft the Bürge (bondsman) places himself under a duty to the creditor of a third party to be responsible for discharging the third party’s obligation (German Civil Code, § 765). In the context of a payment bond, the Bürge (bondsman) promises to pay the third party/debtor’s (employer’s) debt to the creditor (contractor) if the third party/debtor cannot make payment.
This article was published in Construction Law International, Volume 31, Issue 5, 2015. To read the full article along with cites and notes, please visit the GcilA Knowledge Centre at www.gcila.org/knowledge-center.