Agreement of obligations to keep free

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The agreement of indemnification obligations - an underestimated instrument of contract law

The contractual agreement of hold harmless obligations is still a rarely used contractual instrument. However, such indemnity agreements can be very helpful, especially in multi-party constellations. One particularly relevant example is in the area of very complex and therefore contentious plant construction. Here, indemnity agreements can significantly improve the typically unpleasant position of the general contractor vis-à-vis the client and subcontractor when it comes to the trades of its subcontractors.

The author would like to inform the interested public about this in the following article.

The problem: The “sandwich position” of the general contractor

When it comes to the trades of its subcontractors, the general contractor is to a certain extent “caught between two stools”.

If there is a problem that can be traced back to a subcontractor’s trade, the problem becomes easily visible:

The general contractor has two contractual partners, the client and the subcontractor. Now imagine the following, not uncommon constellation:

The client confronts the general contractor with a notice of defects relating to a subcontractor’s work. From the client’s point of view, the general contractor, as its sole contractual partner, is responsible for the defect. From the general contractor’s point of view, the situation is different, as the subcontractor owes it a defect-free delivery. Consequently, the general contractor will pass this notice of defects on to the subcontractor concerned. In the (rare) ideal case, there is agreement on the defect and the subcontractor will rectify the defect to everyone’s satisfaction. But what happens if the subcontractor goes on strike and rejects the existence of a defect? In these cases, the agreement on hold harmless obligations between the general contractor and subcontractor can help.

What does keeping free mean?

One of the reasons for the (supposed) vagueness of the term “freehold” is probably that, as mentioned at the beginning, freehold agreements are still rather rare today.

In fact, the Federal Court of Justice (BGH) has already dealt extensively and meaningfully with the high practical significance of the assumption of duties to hold harmless

According to this case law of the BGH, which can be described as established, the duty to maintain availability is very far-reaching (see only BGH, judgment of 15.12.2010, ref. VIII ZR 86/09, para. 12). Thus, according to the aforementioned ruling of the BGH, every duty to keep property free includes

“(…) in principle also the duty to defend against unfounded claims of third parties (Senate judgment of June 24, 1970 – VIII ZR 268/67, NJW 1970, 1594 under II 1 b; BGH, judgments of January 19, 1983 – IVa ZR 116/81, WM 1983, 387 under 2 a; of April 19, 2002 – V ZR 3/01, WM 2002, 1358 under II 3; of October 24, 2002 – IX ZR 355/00, BGHZ 152, 246, 255).

The BGH explained its reasoning:

“(….) This is because the assumption of an indemnification obligation is typically intended to relieve the indemnified party of any risk of a claim by third parties and, in particular, not to be exposed to the risk of being sued for a justified third-party claim or to fulfill an unfounded claim in a misjudgment of the factual and legal situation and to have this held against them as their own misconduct (Senate judgment of June 24, 1970 – VIII ZR 268/67, loc. cit. under II 1 b, 2; BGH, judgment of April 19, 2002 – V ZR 3/01, loc. cit.).”

This means:

The party obligated to indemnify must generally relieve the indemnified party of any risk of a claim by a third party and, if necessary, also assume the defense against such a claim.

In the case of an unrestricted duty to indemnify, the indemnified party can therefore expect that the party obliged to indemnify will, so to speak, relieve it of all worries relating to the claims of the third parties concerned.

Consequences of violating the duty to maintain freedom

If the party obligated to indemnify violates the indemnification obligation it has assumed, the important question arises as to what reaction options arise for the beneficiary.

Indemnification claims are not primarily aimed at payment. The indemnified party can therefore not initially demand payment to itself. Conversely, the party obliged to indemnify cannot fulfill its obligation by paying the indemnified party.

However, the indemnification claim can be converted into a payment claim. This requires an unsuccessful deadline to be set for the fulfillment of the primary indemnification obligation. If the party obliged to indemnify seriously and definitively refuses the required indemnification, the claim for indemnification is converted into a claim for payment in accordance with the established case law of the BGH.

If the party obliged to indemnify has breached its obligation to indemnify, e.g. by failing to fulfill its obligation on time, the indemnified party is entitled to claim damages in accordance with Sections 280 (1) and 286 BGB. This claim will at least be for compensation for what the indemnified party had to pay to the third party as a result of the breach of duty by the indemnified party.

It is important that the party to be indemnified has given the party obliged to indemnify sufficient opportunity to examine and, if necessary, defend against the claim before making a payment to the third party. If he has done this, the party obliged to indemnify is no longer entitled to object that the party obliged to indemnify has wrongly paid the third party. This is because, due to the breach of his indemnification obligations, he himself is responsible for the fact that the party to be indemnified had to pay the third party.

Particularly relevant: Effects of the indemnification claim on the indemnifying party’s own payment obligations towards the indemnified party

If the party obliged to indemnify breaches its indemnification obligation and thereby exposes the indemnified party to the risks against which it is supposed to protect,

the question arises, which is particularly relevant in general contractor cases, as to what effect this breach of the indemnification obligation has on any outstanding remuneration of the indemnified party (= general contractor) vis-à-vis the party obliged to indemnify (= subcontractor). In these cases, it will usually be the case that the client (= the third party) in turn withholds remuneration from the general contractor.

A contractual obligation to remain free in general contractor constellations under construction law

must, in implementation of the BGH case law cited above, also include the retention of the third party. This is because, according to established BGH case law, retention means keeping free,

- to relieve the indemnified party of any risk of claims by third parties, and

- Accordingly, if necessary, to assume the defense against such a claim,

then, of course, the person obliged to grant the exemption must also submit a corresponding

prevent or suitably defend against the retention of this third party.

As a result, the party to be indemnified can therefore pass on the third party’s retentions, which are at least also based on the breach of the indemnification obligations, to the party obliged to indemnify.

Conclusion on the meaning and purpose of retention obligations

Indemnification claims are a far-reaching and flexible instrument, especially for general contractors, in order to shift a significant part of the risk they typically assume to the subcontractors involved.
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