Modification of contracts and contractual penalties in public contracts under Shield 4.0
As a result of the pandemic, many planned and existing contracts have been paralysed. The uncertain situation forces the parties to cease performing contracts or at least poses barriers to performance. In this situation, can they change the contract? Will they have to pay contractual penalties and damages? The situation now looks somewhat different than it did at the start of the pandemic.
To reduce even a little the uncertainty of parties to public contracts and to help prevent potential disputes over performance of obligations under crisis conditions, the 31 March 2020 amendment to the Anti-Crisis Act (Act on Special Solutions for Preventing, Countering and Combating COVID-19, Other Infectious Diseases, and Crises Caused by Them of 2 March 2020) added Art. 15r. It applies to all types of public procurement contracts, i.e. for supplies, services, and construction works.
Only new contracts, or also existing ones?
Among participants in the public procurement market, doubts have arisen on which contracts are covered by the Anti-Crisis Act: only those from prior to outbreak of the pandemic, or also those concluded during the pandemic? Or perhaps the boundary date should be set at entry into force of the amending act (31 March 2020) introducing Art. 15r, which touches on this issue? The law does not expressly resolve this, and thus the issue requires examination.
The Anti-Crisis Act refers to all public procurement contracts. There is no legal basis or logical justification (considering the aim of the regulation) to say that it should apply only to contracts existing upon entry into force of the act. This doesn’t change the fact that the real impact of the Anti-Crisis Act on public procurement contracts will be modest.
With respect to contracts concluded before the pandemic, the act only repeats the possibilities already provided for by Art. 144(1)(3) of the Public Procurement Law. But with respect to contracts concluded during the pandemic, the general rules of civil law apply, which can limit or exclude a party’s ability to rely on standard contractual provisions on force majeure.
Art. 144(1)(3) of the Public Procurement Law refers to “circumstances which the contracting authority, acting with due diligence, could not have foreseen.” Thus in the case of contract procedures now being commenced, the pandemic as such cannot be regarded as an unforeseen circumstance. But effects of the pandemic which have not yet occurred might meet this test if it turns out that they were unforeseeable. In any event, Art. 15r of the Anti-Crisis Act, introducing the rule on changes to contracts connected to COVID-19, also cross-references the grounds under Art. 144(1)(3) of the Public Procurement Law for modification of a contract, namely:
- The change proves to be necessary, and
- The need for the change was caused by circumstances which the contracting authority could not foresee.
It should be stressed, however, that conclusion of a contract under the current conditions entails a risk of loss of protection also due to the unforeseeable effects of the pandemic. This is because it might be alleged that a reasonable contractor should foresee difficulties connected with the current situation and take them into account when assuming new obligations, to ensure that the contractor is in a position to fulfil them.
In new contracts not governed by the Public Procurement Law, it is recommended to add provisions addressing the potential inability to perform the contractual obligations due to the coronavirus, as well as other issues related to the current situation. During public procurement procedures announced during the course of the pandemic, provisions are typically included reflecting the present realities. For example, clauses are introduced under which the contractor has a duty to minimise the risk of impact of COVID-19 on performance of the contract. This reinforces the contractor’s duty to attempt measures mitigating the impact of force majeure, a duty that exists in every case even if not expressly stated in the documentation. Another example is establishing a duty to replace key personnel with other personnel if the key personnel are unavailable for reasons related to COVID-19.
Duty to report on impact of COVID-19 epidemic on contract performance
The basis for potential modification of contractual relations between the contracting authority and the contractor is their ongoing, mutual reporting on the impact of the COVID-19 epidemic on performance of their contract. This obligation exists not only when such an impact has occurred, but also when it could occur.
Informing the other party to a contract of circumstances that could be relevant for proper or timely performance of the contract should be based on an analysis of the specific procurement, and not general facts related to the current conditions for performance of contracts. In reporting to one another, the parties must indicate the connection between circumstances caused by COVID-19 and the difficulty or impossibility to perform the specific contract.
It should be stressed that this obligation applies to both the contractor and the contracting authority, and is intended to improve the effectiveness of arrangements between the parties. The Anti-Crisis Act gives examples of some issues that could be addressed in these statements, and also the documents that could be annexed to the notice of difficulties provided to the other party:
- Absence of employees or personnel working on a non-employment basis who are participating or could participate in performance of the contract
- Decisions issued by the Chief Sanitary Inspector or province sanitary inspector in connection with combating COVID-19, obliging the contractor to take certain preventive or oversight activities
- Instructions or decisions issued by province governors, the Minister of Health, or the Prime Minister connected with combating COVID-19 referred to in Art. 11(1)–(3) of the act (compulsory conclusion of contract)
- Breakdown of the supply chain
- Other circumstances preventing or significantly limiting the possibility of performing the contract
- Similar circumstances affecting subcontractors or sub-subcontractors.
For the sake of clarity, the law also states that in the case of contractors registered or conducting operations connected with performance of the contract outside of Poland, instead of the documents mentioned above, documents issued by the relevant institutions in those countries should be filed, or statements by the contractors.
This is an open-ended list, only providing examples of information, documents and statements by parties to the contract. Any documents would be suitable if they contain information concerning circumstances related to the occurrence of COVID-19 impacting proper performance of the contract.
But the mere fact that the act includes a list of examples may incline the parties to limit themselves to documents mentioned in the list. Contracting authorities may resist accepting other documents not mentioned in the act.
The act allows the parties to a contract to demand additional statements or documents to supplement the information and confirm the negative impact of circumstances connected with COVID-19 on performance of the contract. The Anti-Crisis Act does not set any deadline for providing additional statements or documents. It is stated in the justification for the bill that self-supplementation is also allowed.
A party to the contract is to submit the collected documents and statements to the other party, which has 14 days from receipt to prepare its position on the impact of the indicated circumstances on performance of the contract. In the justification for the amendment it is additionally stated that it will be impermissible to ignore the notification and not consider the information and present a position to the other party. However, this regulation does not provide for any sanction for failure to meet the stated deadline, which means that the other party can delay its response, missing the deadline set by the law for making vital arrangements in this respect.
Modification of public contract
The duty of ongoing reporting between the parties discussed above will be crucial for making modifications to the contract under Art. 15r (4) or (4a) of the Anti-Crisis Act. Obviously, in most instances it will be the contractor informing the contracting authority of the impact of the pandemic on performance of the contract, not the other way around.
The 19 June 2020 amendment to the Anti-Crisis Act divided the grounds for modification of a public procurement contract into mandatory grounds and optional grounds, depending on whether circumstances connected with COVID-19 are impacting performance of the contract or only could potentially impact performance. The earlier Art. 15r(4), providing for the possibility of contract modification, was moved to Art. 15r(4a), and the amended Art. 15r(4) now refers exclusively to mandatory modification of the contract.
The first thing to consider is the regulation on mandatory modification of the contract because of its direct connection with circumstances related to the epidemic. If the contracting authority finds that circumstances connected with COVID-19 are affecting due performance of the contract, it shall modify the contract in agreement with the contractor. Such modification will correspond to Art. 144(1)(3) of the Public Procurement Law, and may consist of:
- Modification of the period for performance of all or part of the contract, or partial suspension of performance of all or part of the contract
- Modification of the method of performance of supplies, services, or construction works
- Modification of the contractor’s performance and a corresponding modification to the contractor’s fee or the method for calculating the contractor’s fee.
The list of possible changes to a public contract presented in Art. 15r(4) is open-ended. The parties may also make other changes not mentioned in this provision. A change in the method of performance of supplies, services, or construction works may be made with or without a time limit. Similarly, a change in the scope of the contractor’s performance may be temporary or definitive, and that lies exclusively within the discretion of the parties to the contract.
Changes in the scope of the work performed by the contractor will in most instances entail a change in the contractor’s fee. In repeating the restrictions in amount based on Art. 144(1)(3) of the Public Procurement Law, the act underlines that any changes based on the Anti-Crisis Act are possible only when the increase in the fee caused by each successive change will not exceed 50% of the original value of the contract. The act thus allows for the possibility of multiple changes, as is also confirmed in the justification for the Anti-Crisis Act.
The optional ability to modify a public contract introduced by the amendment of 19 June 2020 is framed differently. It provides that if it is found that circumstances connected with COVID-19 could impact proper performance of a public contract, the contracting authority may, in agreement with the contractor, make a modification to the contract in accordance with Art. 15r(4). Thus, in such case the contracting authority may modify the contract, but is not required to do so. In practice, the decision on modification of the contract will depend on the good will of the contracting authority, which in consultation with the contractor may draw on the examples of modifications mentioned in Art. 15r(4) or make other changes.
It is helpful that the Anti-Crisis Act expressly excludes liability under the discipline of public finances or the Criminal Code, and also excludes an allegation of waste or mismanagement when the procedures provided for in the Anti-Crisis Act (Art. 15s–15u) are followed. This provision should expedite the decision-making process by contracting authorities and afford them the flexibility they need and encourage them to take advantage of the possibilities discussed above.
Regardless of whether circumstances connected with COVID-19 actually impact or only might impact performance of the contract, if the public contract contains a more advantageous provision regarding the contractor’s situation that would result from the rules of the Anti-Crisis Act, those provisions will apply to modification of the contract. However, the law also states that circumstances connected with COVID-19 cannot constitute sufficient grounds on their own for renouncing the contract.
Contractor’s liability in damages
If the contractor demonstrates a negative impact of the pandemic on performance of the contract, resulting for example in improper performance, delay, or the inability to perform specific contractual obligations, the contracting authority may refrain from charging the contractor penalties provided for in the contract, or reduce the amount of the penalties.
As the drafters explained the reasoning behind this provision in the justification for the 31 March 2020 amendment, “Contactors’ potential violations of contractual obligations, e.g. involving the time of performance, may be treated by contracting authorities as non-performance or improper performance of the contract. This can mean ascribing liability to the contractors for damages, authorising for example enforcement of contractual penalties, in a situation where improper performance of the contract was due to circumstances directly related to occurrence of COVID-19, and thus independent of and external from the contractors.”
A party to a public contract to whom problems in contract performance are reported should respond to the notification, presenting its position on the impact of the pandemic on performance of the contract by the notifying party (under Art. 15r(3) of the Anti-Crisis Act), and also determine the impact of the COVID-19–related circumstances on the rationale for establishing and enforcing contractual penalties or damages.
Thus in practice the contracting authority will have to inform the contractor whether in its view the circumstances indicated by the contractor constitute or could constitute grounds for releasing the contractor from liability for non-performance or improper performance of the contract, and whether this will also be reflected in contractual penalties charged.
As in the case of optional modification of the contract, on the issue of contractual penalties as well the decision is left to the discretion of the contracting authority. This mechanism does not work automatically, and does not entitle contractors to claim relief from the duty to pay contractual penalties.
Contractual penalties under contracts concluded before change in circumstances
In the case of contracts concluded before occurrence of the special circumstances and imposition of administrative measures connected with the spread of SARS-CoV-2, the absence of grounds to impose contractual penalties on contractors arises under the general principle of civil law set forth in Art. 471 of the Civil Code. Under that provision, it is unlawful to impose contractual penalties on a contractor in a situation where it has failed to perform the contract properly or on time due to circumstances caused by a pandemic. Such contractual penalties are not owed to the contracting authority.
But evidentiary issues play a key role here. First, the contractor must be certain the non-performance or improper performance of the contract is due to circumstances connected with the pandemic. Second, the contractor must have evidence demonstrating the negative impact of these circumstances on performance of the contract. Due diligence must be exercised in gathering such evidence, from beginning to end of that impact.
Ban on setoff of contractual penalties and enforcing contract performance security
The 19 June 2020 amendment to the Anti-Crisis Act also introduced special rules designed to protect the financial liquidity of parties to public contracts.
Under Art. 15r¹, introduced by the amendment, the contracting authority:
- Cannot set off a contractual penalty reserved for non-performance or improper performance of a public contract against the contractor’s fee or other claims of the contractor, and
- Cannot seek satisfaction by enforcing security for proper performance of the contract.
The aim of this provision was to relieve contractors of additional financial burdens that could negatively impact their budgets during the period of battling the effects of the epidemic and adjusting to the new circumstances. This ban will be effective during the period when a state of epidemiological threat or state of epidemic is in force in connection with COVID-19 and for 90 days after such state is called off, if the event for which the penalty was reserved occurred during the period when such a state was in force.
The justification for this provision asserted that the current economic situation caused by the COVID-19 epidemic is worsening the economic condition of a large number of contractors on the public procurement market. The deepening of this process could cause contractors to lose their financial liquidity, and in consequence their capacity to win new public contracts and to perform existing public contracts.
However, the ban on setting off contractual penalties does not extinguish the contracting authority’s claim. Under Art. 15r¹(2), during the period when this ban is in place, the limitations period on the contracting authority’s claims shall not begin to run, and if already begun shall be suspended. Moreover, the limitations period shall expire no earlier than 120 days after the lifting of the last of these states. Consequently, the contracting authority will not forfeit such claims but will have to refrain from enforcing them. Meanwhile, the contractor will have sufficient time to adjust to the new market conditions.
Expiration of security instruments
The ban on enforcing contract security is not absolute, as under Art. 15r¹(3) of the Anti-Crisis Act, if the security for proper performance of the contract will expire during the period when a state of epidemiological threat or state of epidemic is in force or the following 90 days, the contracting authority may not seek satisfaction out of the security, on condition that 14 days before expiration of the security, the contractor extends the validity of the security or submits new security whose terms are accepted by the contracting authority.
Expiration of the security will not extinguish the contracting authority’s claim, and if the contractor does not maintain the validity of the security, the contracting authority will be entitled to enforce the security. Thus it is in the contractor’s interest to extend the validity of the security.
If the validity of security for proper contract performance expires between the 91st and 119th day after the state of epidemiological threat or state of epidemic in connection with COVID-19 is cancelled, the validity of the security is extended by operation of law until the 120th day after cancellation of such state. It should also be underlined that in calculating all of the periods referred to in Art. 15r¹ of the Anti-Crisis Act, the date of cancellation of the state of epidemiological threat or state of epidemic due to COVID-19 is included in those periods.
Dr Hanna Drynkorn, Cyprian Herl, Infrastructure, Transport, Public Procurement & PPP practice, Wardyński & Partners