Poland

Dr Rafal Morek
CMS, University of Warsaw

Guarantee of payment for construction works

On 16 October 2023, an amendment to the Polish Civil Code^[1] entered into force to exclude the application of the provisions on the guarantee of payment for construction works when the investor is the State Treasury.

The Act has retroactive effect, also applying to ‘construction contracts concluded before the date of entry into force of this act, with respect to which the contractor did not request the submission of a guarantee of payment for construction works before that date’.

Since 2010, Polish law has provided for the right of a construction contractor to request that an investor provide a ‘guarantee of payment for construction works’ in the form of a bank or insurance guarantee, bank letter of credit or bank surety, ‘to secure the timely payment of the agreed remuneration for the performance of construction works’ (Article 649(1), section 1 et seq. of the Civil Code).^[2] Until now, these provisions have applied to all investors and contractors, according to the following rules:

• the contractor may, at any time, demand from the investor a payment guarantee up to the amount of any claim for the contractual remuneration and additional works or works that are necessary for the performance of the contract, accepted in writing by the investor (Article 649(3), section 1 of the Civil Code);

• the investor and the contractor bear the costs of establishing the guarantee in equal parts (Article 649(1), section 3 of the Civil Code);

• if the contractor fails to obtain the requested payment guarantee within the time limit it has set, which is not less than 45 days, the contractor is entitled to withdraw from the contract due to the investor’s fault (Article 649(4), section 1 of the Civil Code); and

• the contractor’s right to demand a payment guarantee cannot be excluded in the contract (Article 649(2), section 1 of the Civil Code).

The Act excludes the application of these provisions when the investor is the State Treasury. According to the explanatory memorandum for the Draft Act, the following arguments are meant to support the amendment.

Firstly, Article 649(1) of the Civil Code was introduced into the Civil Code in 2010 to ‘prevent negative phenomena in the economy, in particular the failure of investors to pay for works performed by construction contractors’. In the case of the State Treasury, there is no such risk, as the Treasury is a ‘credible investor providing a guarantee of solvency’.

Secondly, the issuance of the guarantee entails significant costs for the Treasury. Although Article 649(1), section 3 of the Civil Code guarantees that the parties bear them in equal parts, ‘[i]n practice, such costs are borne by the public finance unit, which then seeks reimbursement of half of the costs from the contractor, which does not always happen quickly and sometimes means waiting for years for the conclusion of litigation’. In this context, the State Treasury’s exemption from the obligation to provide a payment guarantee is ‘beneficial for the state budget’.

Thirdly, the amendment of Article 649(1) of the Civil Code is allegedly consistent with similar instruments providing protection for the State Treasury (eg, Article 749 of the Civil Procedure Code, which stipulates that it is inadmissible to secure monetary claims against the State Treasury).

Fourthly, the amendment is intended to counteract the abuse of the payment guarantee institution for contractors to withdraw from their construction contracts. In this context, it was pointed out that:

‘There are cases where the contractor uses payment guarantees contrary to their intended purpose. The contractor, seeing the risk that the investor will withdraw from the contract due to its fault (for example because of a delay in implementation) and charge the associated liquidated damages, using the payment guarantee instrument, can not only avoid the risk of potential liquidated damages, but completely reverse the situation. Instead of paying damages, the contractor itself can raise financial claims against the investor.’

The above arguments call for certain polemical remarks.

Guarantee of solvency does not mean guarantee of payment

While it is difficult to argue with the axiom that the State Treasury is a ‘credible investor which provides a guarantee of solvency’, one could question whether it is proper in the context of said institution. Experience has shown that ‘guarantee of solvency’ does not always mean ‘guarantee of payment’, especially ‘timely payment’. In practice, the question of ‘when’ the payment will be made proves to be no less important for construction companies than ‘whether’ it will take place at all.

Continuity and liquidity of financing (cashflow) is crucial to the operation of construction companies. Construction production is capital-intensive. An investment requires an ongoing supply of capital from the investor itself. Therefore, the guarantee of payment for construction works was originally meant to secure not only the payment of the agreed remuneration for the construction works itself, but also its ‘timeliness’. This follows verbis legis from Article 649(1), section 1 of the Civil Code, according to which the payment guarantee is intended to protect ‘the timely payment of the agreed remuneration for the performance of construction works.’

Excluding the possibility of demanding a payment guarantee from the State Treasury as an investor may therefore worsen the situation of contractors, regardless of the axiom of the State Treasury’s solvency. If the State Treasury, as the investor, refuses to make payment for any reason – for example, invoking a set-off of the contractor’s remuneration against contractual penalties or counterclaims (which may be disputable) – the contractor may lose hope of receiving its payment other than at the end of a lawsuit lasting many years. For all that time, the cost of the completed and unpaid works will be borne by the contractor. Although in the event of a successful lawsuit the contractor can count on interest for delay, it often does not compensate for the various negative consequences of the disruption of the cash flow. Payment congestion can lead to ‘chain reactions’ and even trigger waves of business bankruptcies.

The thesis of the need to combat the abuse of payment guarantee through changes in the law is questionable

It follows from the explanatory memorandum for the Draft Act that the amendment is intended to counteract the phenomenon of contractors ‘abusing’ Article 649(1) of the Civil Code – ie, using the demand for a payment guarantee as a ‘weapon’ in a dispute with the investor, including using the failure to provide the required guarantee as grounds for withdrawal from the contract.

The claim about the phenomenon of abuse of the law and the need to combat it through legislative intervention does not seem valid. Firstly, it has not been supported by any empirical data, studies or court decisions. Secondly, the provision of a payment guarantee under Article 649(1) section 1 of the Civil Code is not free of charge for the contractor. The relatively high cost of establishing a guarantee is one of the reasons why many contractors refrain from requesting this instrument.

Thirdly, the mere request of the contractor to the investor for a payment guarantee does not give grounds for withdrawal from the contract. Such grounds arise only when the investor fails to provide the contractor with a guarantee within a time limit (not less than 45 days), or when the provided guarantee does not meet the statutory requirements. In other words, it essentially depends on the investor whether the failure to respond properly to the demand for a payment guarantee will give the contractor grounds for withdrawal.

Fourthly, it is difficult to treat as an ‘abuse’ the contractor’s exercise of a right that arises ex lege in the event of the investor’s failure to perform a statutory obligation. In such situations where the contractor’s behaviour contradicts the principle of ‘clean hands’, takes the form of abuse or other conduct where demand for a payment guarantee detracts from the purpose of this institution, the investor – the State Treasury – can successfully seek protection through the courts, using existing institutions such as Article 5 of the Civil Code.

The principle of equal treatment under civil law

The explanatory memorandum of the Draft Act declares that the proposed amendment ‘does not violate equality before the law’. However, it does not dispel doubts about the compatibility of the proposed solution with the principle of equal treatment under civil law.

The provisions of the Civil Code on the construction contract do not differentiate de lege lata the rights and obligations of the parties on the basis of entity-related criteria. The contractor can demand payment guarantees – lege non distinguente – from both private and public investors. Accordingly, the obligation to submit a payment guarantee at the request of the contractor is equally incumbent on all investors. The amendment will change this by putting the State Treasury in a better position than all other investors – both public and private.

The rationale behind the amendment is to protect the fiscal interests of the Treasury and to protect the Treasury against the risk of contractor withdrawal.

However, a question arises as to why the beneficiaries of these benefits should not be – in addition to the State Treasury – local government units or other entities that share with the State Treasury the attribute of legally guaranteed solvency?

Finally, according to Article 649(5) of the Civil Code, Articles 649(1)–649(4) of the Civil Code apply to contracts concluded between a contractor and further contractors (subcontractors). The Act does not explicitly answer the question of how the State Treasury’s preferential treatment will affect the legal relationships between the general contractor and subcontractors. Will the contractor – deprived of the possibility to obtain payment guarantee from the State Treasury – continue to be obliged itself to establish analogous guarantees for the benefit of subcontractors? The recitals of the explanatory memorandum lead one to answer the question in the affirmative, but the issue raises doubts that may long await resolution in case law.

Change to the allocation of risks and contractual balance during contract implementation

Issues related to guarantees of timely payment of remuneration are an important part of the assessment of contractual risks associated with the implementation of investments. The Act therefore raises concerns, among other things, from the perspective of intertemporal norms and retroactive effects. Taking away the contractor’s right to demand a payment guarantee – already in the course of contract performance – will lead to interference in the content of the contractual relationship, which was not anticipated by the parties when concluding the contract, and to a violation of the existing consensual contractual balance between the contractor and the investor. In other words, for the contractor, who is deprived of the possibility of obtaining a payment guarantee after the conclusion of the contract, such a change is not neutral.

It is the moment of contract conclusion (and in some cases, the submission of a binding offer or the opening of bids), and not the date of the request for the establishment of a payment guarantee (as provided for in the Act), that should be considered conclusive from the point of view of assessing respect for the principle of non-retroactivity of civil law (reflected in Article 3 of the Civil Code). Deprived of the payment guarantee, a contractor could either not submit a bid at all or submit it with a different bid price.

Final comments

The assessment of contractual risk translates into the valuation of bids submitted by potential contractors. Risk ‘drives up’ the price. By aggravating the situation of contractors, the amendment may limit their ‘appetite’ to bid for such contracts, lead to higher bid prices, and induce them to seek opportunities to bid for other investors’ contracts. Consequently, both the legal and economic sense of the amendment – putting the State Treasury in a different position than all other investors – seems questionable.