Between a rock and a hard place: General contractors squeezed by investors’ joint and several liability regime
Since the introduction to the Civil Code and later the Public Procurement Law of provisions on the investor’s joint and several liability for payments due to subcontractors of construction works, general contractors find themselves trapped between the need to supervise and discipline subcontractors and the pressure from the investor to pay them.
Only in Poland
Although construction companies operating in Poland for a longer time, both domestic and foreign, have grown accustomed to this mechanism, it is worth mentioning by way of introduction that the investor’s joint and several liability to subcontractors (Art. 6471 of the Civil Code and Art. 143c of the Public Procurement Law) appears to be a solution unique to the Polish legal system; similar solutions are rare in other countries. Among foreign investors or contractors just entering the Polish market, it causes at least surprise or even shock.
No wonder then that there are (although less and less frequently) attempts to exclude this regime, among other things by choosing foreign law for (sub)contracting agreements. However, as a rule, they are doomed to fail. The provisions on joint and several liability are absolutely binding, and from the perspective of private international law they would most likely be considered mandatory provisions, binding independently of the law governing the contract.
Do the provisions really protect subcontractors?
Such (formally) strong protection of subcontractors by the parliament is no coincidence. The provisions on joint and several liability were introduced into Polish law at a time when, unfortunately, the Polish construction sector was experiencing a recurrent cyclical crisis, in order to prevent a wave of subcontractors’ bankruptcies due to payment gridlock on the part of general contractors and sometimes their own bankruptcies.
However, despite the declared objective, the provisions on the investor’s joint and several liability often play a different role in reality, as leverage in negotiations with the general contractor or a way to bypass the general contractor in payments. Thus they reduce the effectiveness of the tools for discipline and supervision available to the general contractor, such as charging contractual penalties or withholding payments. Nor can this rather incidental effect of the regulation be regarded as entirely negative, as it balances in a certain sense the positions of subcontractors and general contractors. And sometimes the investor’s joint and several liability does fulfil its intended function of protection against insolvency. This is the case with the increasingly frequent abandonment of construction sites by the general contractor without paying the subcontractors, and in the case of bankruptcy.
What is the general contractor afraid of?
In the absence of statistics, it is difficult to speculate which function this rule performs more often in practice. However, from the perspective of the general contractor, the spectre of joint and several liability is above all a threat that must be avoided—and this has not been changed by the latest amendment to Art. 6471 of the Civil Code.
The existence of the investor’s joint and several liability can place the general contractor between a rock and a hard place. On one hand, it must seek declarations of no arrears from the subcontractor in order to obtain full payment itself from the investor, but on the other hand, it has an interest in supervising and disciplining the subcontractors, even if only to avoid the investor’s objections as to the time and quality of executed works. It is often impossible to reconcile these contradictory considerations.
During contract performance, it is in the interest of the general contractor to ensure, first and foremost, that no fee is paid to a subcontractor for work whose quality is disputed, and that the payment is not made in avoidance of the general contractor’s counterclaims against the subcontractor in question. Direct payment does not deprive the general contractor of its claims against the subcontractor, but it does make it difficult to enforce them.
Consequences difficult to overturn
It is worth analysing the consequences of a sample worst-case scenario, where the general contractor first deducts its claim, e.g. for a contractual penalty, from the subcontractor’s claim for payment, and yet the entire tranche payment, not reduced by the setoff, is paid to the subcontractor by the investor. Regardless of the investor’s motives (such as a lack of awareness, a different assessment of the situation, relations with participants in the construction process), this situation raises several questions.
First of all, can the general contractor in such a situation demand payment of the full fee from the investor?
If only in reality the setoff was ineffective, i.e. the investor made a mistake in making a direct payment, then in legal terms the general contractor retains its claim for payment of its entire fee. An effective setoff is legally equivalent to a payment—in a sense it is a specific form of payment, where the counterclaim is the “settlement currency.” Thus, if the general contractor makes a valid setoff, the subcontractor is satisfied in that part and the investor is relieved of that liability. A direct payment by the investor in such a situation is an independent payment which does not give rise to any recourse by the investor against the general contractor and therefore cannot lead to a reduction of the payment due the general contractor.
The general contractor could successfully pursue its case in court, especially as it would have a very favourable distribution of the burden of proof. It would only have to prove that work has been done for which payment is due, which should be undisputed if the investor paid the subcontractor for it. On the other hand, the investor would bear the difficult burden of proving from its standpoint that the contractual penalty imposed by the general contractor was unjustified or the setoff was invalid for formal reasons.
However, the question is whether it is possible to avoid a time-consuming court case, e.g. by setting off the same receivable from the next tranche of the subcontractor’s fee, hoping that this time the investor can be persuaded to see it the general contractor’s way—if only because more evidence has been collected or because the investor has learned from the mistake resulting from its lack of awareness.
Unfortunately, the answer is no, which follows from the earlier comments. Since the setoff was an effective payment, it also led to the cancellation of claims for a contractual penalty. Setting it off again would be like a second demand for payment of the same amount. What is worse, it is not possible to set off the overpayment claim, i.e. for unjust enrichment, because in such situation, it is only the investor who is entitled to that claim.
So what else can be done? If the general contractor has a (very) good relationship with the investor, it can, for example, persuade it to assign the overpayment refund claim, which can then be applied when paying the next tranche to the subcontractor, by way of setoff.
It should be noted by the way that when considering mutual settlements between the general contractor, subcontractors and the investor, the exact sequence of events is crucial. If the only detail different in the above scenario is that the setoff of the contractual penalty by the general contractor took place after the direct payment by the investor, the general contractor would have retained the right to demand payment of the penalty from the subcontractor, but it would probably have no claim for payment from the investor—assuming that the investor itself had made an effective setoff of the recourse claim in the amount of the direct payment made.
An ounce of prevention
However, it is best to avoid direct payment by the investor for the subcontractor’s contentious claims as much as possible.
At the stage of concluding the contract with the investor, the general contractor should ensure an absolute right to address any request for direct payment, and an obligation on the investor’s part to inform the general contractor of the subcontractor’s claims before payment is made. In practice, investors usually take care of this themselves, as it is in their own interest, but it should be secured by a contractual provision.
If the subcontractor’s contractual penalties have to be set off during the implementation phase, the general contractor should carefully record the evidence of entitlement to the penalties and ensure that the allegations against the subcontractor are clearly set out in the official correspondence, preferably before it makes a direct claim. All this is necessary to avoid undermining the credibility of the general contractor’s claims in the eyes of the investor, and in the long term, in the eyes of the court.
It is also important that the claims to be set off are properly selected. If the general contractor wants to stop a possible direct payment, it should invoke easiest verifiable claims. Usually, a contractual penalty for delay in a strict sense, i.e. independent of fault, is the most reliable tool. At the opposite end of the spectrum are claims based on quality issues, i.e. defects in the work performed. To ensure that such a request does not raise any doubts on the part of the investor, it is advisable to commission an independent technical expert’s report, which will not replace the later opinion of a court-appointed expert but must suffice at the stage of contract performance. The weakest instruments for stopping direct payments are claims not related to the project, due to the investor’s lack of knowledge on the subject and lack of an interest in disciplining the subcontractor in this respect.
Will something change?
There is no indication that, apart from revisions such as those introduced by the 2017 amendment, the mechanism of joint and several liability of the investor will undergo serious changes, not to mention disappear from Polish law. For this reason, participants in the construction process—including general contractors, who have been put in a difficult situation—have to adapt to the situation so they can consciously and effectively limit the associated risks.
Maciej Zych, adwokat, Dispute Resolution & Arbitration practice, Wardyński & Partners