Demand for a payment guarantee – an underestimated attribute in the hands of construction contractors

The current realities on the construction market – concerning both the increase in the cost of building materials and problems with their availability – lead to a situation in which contractors responsible for the implementation of works often face a dilemma: whether it will be a greater cost for them to complete the task or to resign and incur the related contractual consequences.

The situation is particularly problematic in the case of investments carried out by public investors – who, acting in accordance with the regime of public procurement law and the provisions of the Act on the discipline of public finances, are definitely more conservative in terms of valorization of the remuneration of contractors performing construction works. In this type of projects, as a rule, withdrawal from the contract by the contractor is subject to a contractual penalty, what’s more – the issue of cost increase is imposed with delays in the implementation of works, which also cause the calculation of contractual penalties.  In the absence of agreement between the parties on the change of the date and amount of remuneration, the prospect of “freeing” themselves from the concluded contract becomes all the more attractive  for contractors.

In the case of public procurement, however, it should be borne in mind that withdrawal from the contract, or more broadly – “abandonment” of works by the contractor in any legal formula – has a greater specific weight than in the private sector: it means not only the lack of references for investments with specific parameters (some of which are impossible to obtain on the commercial market), but may also in the future be a reason to try to exclude the contractor from subsequent proceedings,  based on Article 109(1)(5) or (7) of the Public Procurement Law. Under these conditions, the “grail” for contractors was a solution that would allow them to withdraw from the contract, without incurring the above risks  and consequences. Practice indicates that such a solution has been found and is beginning to be used – in an instrumental way – by performers, and this phenomenon may still gain strength. This solution is the provisions of Article 649¹ of the Civil Code, entitling the contractor to demand that the investor establish a guarantee of payment for construction works.

According to the aforementioned regulations, at the request of the contractor of construction works, the investor is obliged to establish a guarantee of payment of remuneration for the performance of these works – however, such a right on the part of the contractor cannot be excluded or limited by means of a legal act (Article 649 § 1 of the Civil Code). If the appropriate guarantee is not established within the time limit set by the contractor, not shorter than 45 days, the contractor under the provision of Article 649 § 1 of the Civil Code is entitled to withdraw from the contract due to the fault of the investor. From the contractor’s perspective, such a step not only frees the contractor from the obligation to carry out further works that bring losses, but also destroys the effectiveness of the provisions on contractual penalties regarding the deadline for implementation (at least in terms of failure to meet the final deadline), what is more – it opens the field for discussion about the obligation to pay a contractual penalty for withdrawal from the contract for reasons attributable to the investor (if any).  Therefore, it is easy to see that if the investor fails to comply with the obligation to establish a payment guarantee, the contractor gains very serious arguments, allowing him to end the unprofitable cooperation on favorable terms – which he can also use as part of negotiating an annex to the contract.

It might seem that in the case of contracting authorities from the public sector, the provisions of Article 649 § 1. of the Civil Code will not apply in practice at all, and even more so – they will not be the source of the problem: after all, we are talking about solvent entities that can hardly be suspected of intending to evade the settlement of obligations arising from the contract. So what is the problem?

First of all, it should be noted that the right to demand the establishment of a payment guarantee from the investor is in no way limited. Although the genesis and ratio legis of the provision indicate that the contractor is protected against the risk of the investor’s insolvency, and the right to refrain from engaging the contractor’s own funds in the project – until the collateral is established, the provision does not introduce any subjective or time limitation. In other words, even in cases where the investor’s solvency is not in doubt, or the demand for security is unreasonable (due to the fact that the works have been almost entirely carried out – and the contractor’s funds are already involved), the right to demand a payment guarantee is not limited. Thus, they can be sent even at the last stage of the works, to an entity with proven solvency – and it must establish an appropriate security.

The second practical problem faced in practice by public contracting authorities is the limited possibility of obtaining appropriate security. The investor may be obliged to submit it within 45 days – which is a short period, taking into account the procedures for selecting service providers for services financed from public funds (and this is the guarantee service). In addition, there are no products of this kind on the market that would be dedicated to public entities – e.g. local government units, because so far there has been no such demand. It happens that investors have a problem with obtaining a guarantor.

Finally, the last barrier – the content of the guarantee. In practice, the demands for the establishment of a guarantee of payment of an unconditional nature – i.e. providing for the payment of remuneration by the guarantor of the entire remuneration specified in the contract, without the need for the contractor to prove that the object of the works has been fully and correctly performed (e.g. by making the payment of the guarantee service dependent on the presentation of a protocol of acceptance of works). For a public entity, the establishment of this type of guarantee is problematic – it may result in an expense that is not covered by the purchased object of work, while the problem is even more complex in the case of projects financed from external funds, e.g. EU grants.  Finally, the scope of the remuneration covered by the payment guarantee may be disputed: under Article 649(1) of the Civil Code, the obligation to establish payment also includes remuneration for additional works accepted in writing by the investor. In the contractor’s opinion, such works may be, for example, works confirmed in a note (or commissioned by an entry in the construction log) by the investor’s supervision, acting for the investor – for contracting authorities within the meaning of the public procurement law without concluding an annex, it is difficult to make such a payment, even potentially, through a guarantee.

Therefore, as practice shows, it happens that the demand for the establishment of a payment guarantee is difficult for public contracting authorities to meet – at least in a manner fully accepted by contractors. The consequences are far-reaching, reversing the legal situation of the parties in terms of the right to withdraw from the contract and the consequences associated with it. The provision of Article 649 of the Civil Code is therefore a very strong legal tool in the hands of contractors – which they sometimes use in an instrumental way, when the real purpose of the request is not to avoid the risk of insolvency, but, for example, to avoid the consequences of untimely execution of works.

A separate and difficult issue is the defense of investors against such instrumental action of contractors – where it is necessary, among others, to consider in the light of the facts whether such defense should be carried out on the basis of the provisions on the demand for a guarantee, or establish a guarantee, with the intention of defending against its possible abuse.

Authors:

Przemysław Wierzbicki | attorney | Partner at KKLW Legal Kurzyński Wierzbicki

Maciej Łysakowski | Advocate at KKLW Legal Kurzyński Wierzbicki

KKLW Law Firm – offers comprehensive legal advice on the implementation of complex infrastructure projects, including construction contracts. She advises both at the stage of contract implementation as well as at the stage of public procurement procedures. He represents private investors and public contracting authorities in disputes before the National Chamber of Appeal and in court disputes.

Last Updated on November 8, 2022 by Anastazja Lach