• Contract Performance Guarantee Of 10% Of The Order Total Required In The General Terms Of Business: Is This Effective?
  • May 13, 2011 | Author: Thomas Richter
  • Law Firm: Sibeth - Munich Office
  • In a ruling of 9 December 2010 (VII ZR 7/10) the Federal Court of Justice stated its opinion on when a client has excessive security and a security agreement could be invalid.

    In the case before the court, the special conditions of contract (ZVB) stipulated that the contractor must provide the client free of charge with a contract performance guarantee of 10% of the agreed order total. According to the special conditions of contract, this guarantee was to secure the contractual and punctual implementation of the performance and to provide security for any rights of the client to repayment arising from over-payments during the construction period. At the same time, the general terms of business stipulated that the client was entitled to hold back a security retention of 10% of the part payments which result from the checked and recognised claims for work performed until such time as the sub-contractor's final invoice is checked and paid. In addition, they allowed the client to set of the retained payments against other receivables arising from the contract for work at any time.

    The Federal Court of Justice (BGH) ruled that a contract performance guarantee of 10% which is included in the client's terms of business is null and void if there is a combination of the provision for a security agreement and another provision concerning the agreements about the part payments because this leads to excessive security to the disadvantage of the contractor.

    The decisive consideration for the Federal Court of Justice was that on the one hand, each of the two provisions on its own did not constitute a violation of the law on general terms of business. The court stated that a contract performance guarantee for 10% of the order total is effective if it applies on its own and is not reinforced by one or more other contractual provisions in such a way that the other party to the contract is at an unreasonable disadvantage (a position also taken by the Higher Regional Court (OLG) of Munich, ruling of 22 December 2009 - 9 U 1937/09).

    In the case under consideration, however, the court believed that the combination of provisions leads to an unreasonable disadvantage. As a result, the Federal Court of Justice ruled that both provisions were null and void because it was not up to the court to decide which of them should remain valid (Federal Court of Justice (BGH), ruling of 26 October 1994 - VIII ARZ 3/94).

    Previously it had been disputed whether security of 5% of the order total as mentioned in Section 14 No. 2 of the old version of the Standard German Procurement and Building Contract Terms (VOB/A) could be seen as an upper limit for the fulfillment of all obligations arising from the contract, although in practice a security of 10% had become established in practice. The Federal Court of Justice (BGH) now confirms the allowability of a claim to this level of guarantee: it considers that security of 10% of the order sum does not place the contractor at an unreasonable disadvantage because the contract performance risk especially arises if the contractor becomes insolvent during the performance of the contract and a third party must therefore be commissioned with the completion of the construction project. It states that the resulting extra cost is often even greater than the contract performance guarantee of 10% of the order total. It considers that even an agreement to provide a guarantee on first demand to secure the performance of the contract does not constitute an unreasonable disadvantage for the contractor. Nevertheless, the principle of the prohibition of excessive security remains: a combination of different forms of security could create an unreasonable disadvantage for the party to the contract, and the provision therefore becomes null and void.