Guarantee of payment or guarantee of withdrawal from contract?

Art. 6491–6495 of the Civil Code is intended to ensure that the security in the form of a payment guarantee for construction works provided at the investor’s request secures timely payment of the contractor’s fee. However, one may suspect that in practice this instrument is used for a completely different purpose.

Statutory right to security

The parliament sometimes decides to grant one of the parties to a contract special security for its claims. This is the case, for example, in a lease agreement, where the lessor is entitled to a statutory pledge on the movable assets of the lessee brought into the premises to satisfy the lessor’s claim for rent (Art. 670 §1 of the Civil Code). A similar solution has been applied in the case of a construction works contract, where the party who may request security is the contractor and a payment guarantee must be provided by the investor (or, more precisely, a bank or insurer acting on its behalf). This guarantee is to secure timely payment of the contractor’s fee (Art. 6491 §1 of the Civil Code).

A harsh sanction

The parliament has defined in a special way the sanction for failure to obtain a payment guarantee. According to Art. 6494 §1 of the Civil Code, if a contractor does not obtain the requested payment guarantee within the period it indicates of no less than 45 days, the contractor is entitled to withdraw from the contract due to the fault of the investor, with effect on the date of withdrawal. Obtaining a guarantee is understood in practice to mean not just issuance of a guarantee letter by the guarantor, but also delivery of the guarantee to the contractor, before the expiration of the set deadline.

High costs

A bank guarantee is an expensive form of security. In its judgment of 27 November 2006 in case K 47/04, the Constitutional Tribunal found that the cost of a guarantee may amount to even 6% of the project value. The legal literature shows slightly different values of 2–4% per year. Nevertheless, these amounts are still significant. Considering that infrastructure projects often amount to tens or hundreds of millions of zlotys, the costs of guarantees become equally astronomical. And the parliament has decided that these costs are to be borne half and half by the concerned parties (Art. 6491 §3 of the Civil Code), even though their origin is decided solely by the contractor and they are incurred solely in the interest of the contractor.

How it works in practice

At the beginning of April, our law firm held a seminar entitled “Subcontractor, general contractor and investor: Joint construction, various interests—legal problems in payment of subcontractors.” We asked the participants whether they deal with payment guarantees in practice. They said that as contractors or subcontractors enjoying a right to protection in relation to the general contractor under Art. 6495 of the Civil Code, they do exercise this right, but only incidentally. It rarely happens that a guarantee is requested at the very beginning of cooperation, at the time the contract is concluded. A contractor has no reason to suspect from the very beginning that the investor will refuse to pay on time, and additionally does not want to bear half of the cost of this security, which, as indicated, may reach millions of zlotys. Therefore, it is not surprising that contractors do not immediately exercise the right vested in them by the parliament.

Contract is one thing, construction another

However, the reality is that what actually happens on the construction site quickly begins to diverge from the contractual arrangements. Schedules become outdated in terms of both time and subject matter. There are additional, substitute works; there are unforeseen circumstances. This happens for instance because even the best design is only a design, and always loses in the confrontation with life, which turns out to be more complex than the most perfect drawings, assumptions or calculations. As a result, the interests of the parties on many construction sites quickly begin to clash: the contractor does not want to undertake further works for fear of not receiving approval, and then payment; delays occur, trust erodes, and correspondence begins to be exchanged in order to secure the best possible legal position for potential future litigation.

A nuclear option

It is often only in such a situation that the contractor realises it has a very effective tool at its disposal, sometimes called the “nuclear option”: it can demand a payment guarantee, not to secure timely payment of its fee, but to have a solid, undeniable basis for withdrawing from the contract and thus exiting an unsuccessful and complicated project. As is also seen in the case law, it is at such moments that a demand for a payment guarantee is typically asserted, and if the guarantee is to be provided within 45 days, on the 46th day the investor receives a statement from the contractor withdrawing from the contract pursuant to Art. 6494 §1 of the Civil Code. In a conflict situation, even if the investor has such a possibility, it usually does not decide to obtain a payment guarantee, as it fears that it will be immediately exercised by the contractor, despite a dispute between the parties.

Was this the purpose?

No definitive conclusions may be drawn from a few statements by members of the construction sector to the effect that the right to obtain a payment guarantee is not being used for its intended purpose, even if supported by the available case law. Further research is needed, including quantitative research, to verify this hypothesis. Nonetheless, we may suspect that often the demand for a payment guarantee is more about a guarantee of withdrawal from the contract, rather than payment. This situation approaches circumvention of law (Art. 58 §1 of the Civil Code), especially if the contractor could not invoke a basis for withdrawal from the contract other than the one provided for in Art. 6494 §1 of the Civil Code. After investigating this problem, the parliament should consider whether the existing solutions need to be changed, especially with respect to the sanction for not providing the requested security.

Marcin Lemkowski, adwokat, Dispute Resolution & Arbitration practice, Wardyński & Partners