Payment guarantee under Article 649(1) of the Civil Code – is this an investor’s problem in the construction process to which the Polish insurance market has no answer?
Over the years, the law governing the performance of construction contracts has undergone many changes. The legislator introduced new regulations in response to the dynamics of the market, because in the face of constant change, some of the regulations turned out to be archaic, and yet the law should have a protective function for the participants in a given process.
Payment guarantee under Article 649(1) of the Civil Code – what is it?
One such provision was Article 649 (1) of the Civil Code, known as the “Payment Guarantee,” introduced in 2010. According to paragraph 1 of this provision, “a guarantee of payment for construction work, hereinafter referred to as a payment guarantee, shall be granted by the investor to the contractor (general contractor) in order to secure the timely payment of the agreed remuneration for the performance of construction work.” The next paragraph 2 of the quoted provision states that “a payment guarantee is a bank or insurance guarantee, as well as a bank letter of credit or a bank suretyship granted on the order of the investor.” The closing provision of paragraph 3 states that “the parties shall bear in equal shares the documented costs of securing the claim.”
The above regulation was established in the reality of the booming construction investment market of the 1990s. At the time, there were numerous investor insolvencies, resulting in defaults on payment obligations to contractors and general contractors. In many cases, this led directly to the bankruptcy of the latter. Unfortunately, the ratio legis of the provision was not written into its content, and its general rule does not reflect the purpose of the provision at the time. The result is that it applies to any construction process, regardless of the financial condition of the investor, as confirmed by recent case law.
The said provision and subsequent provisions of the Civil Code, supplementing and shaping the payment guarantee, have given it the character of a mandatory regulation, the exclusion of which in a contract is ineffective. In addition, a short deadline of 45 days was introduced for the investor to present a payment guarantee on pain of withdrawal by the contractor – the general contractor – from the construction contract through the fault of the investor, which gives rise in practice to further categories of compensation claims.
A big hassle for a small investor.
In today’s market realities, significant players in the real estate market – investors are unlikely to have to fear the application of the described regulation against the ratio legis of its introduction.
However, for developers who undertake the effort to carry out further, larger-than-life investments without full financial security equivalent to at least 140% of the value of the investment, the use of the described institutions of requesting payment guarantees can spell serious trouble.
The legislator has indicated in what forms the investor can provide the guarantee. One of them is a bank guarantee, which, however, may prove too costly for the investor. With its acquisition usually comes the need to secure the provision of such a guarantee by a bank for an amount that exceeds the general contractor’s remuneration.
An insurance product that never existed and does not exist.
It is clear from the wording of the provision that an investor can provide a payment guarantee in various forms, including an insurance guarantee. Despite such a provision, introduced into the Polish legal order many years ago, a product corresponding to the regulations is practically not available on the Polish insurance market. The offerings of the leading insurers on the Polish insurance market do not include such a product at all, or only partially. However, when we seek insurance coverage with an investor, we find that the de facto product is not available. In exceptional situations, priority customers could count on the preparation of offers of such a guarantee, but in the case of the developing investor I am discussing, it is not practical to use such a product.
It may seem that the establishment of the institution of payment guarantee by the legislator by a mandatory provision and the indication of its forms, should prompt Polish insurance companies to offer such an insurance product. Of course, you can try your hand at finding the product in the European Union or Lloyds markets, but this solution may prove too time-consuming and expensive for a Polish investor. An additional difficulty may be the difference between the legal systems of different countries and the understanding by potential foreign insurance partners of the payment guarantee institution existing in our legal order.
However, the described situation in the market for insurance products may have a very practical and negative dimension for at least part of the real estate market. In the current unstable economic times, when material prices, labour availability, a breakdown or at least a slowdown in the supply chain (widely commented on since the beginning of the Sars Cov virus pandemic – 2supply chain interruption), can trigger the will or necessity on the part of general contractors to find an exit from the legal relationship arising from the signed construction contract with the least possible loss. The use of the described provision in a manner contrary to the legislator’s intention may therefore become commonplace, especially in view of the considerable difficulty of obtaining an insurance guarantee covering payment guarantees in Poland.
Awaiting the response of the insurance market.
For obvious reasons, it is known that an insurance product in the form of an insurance guarantee, in the situation described, must involve the payment of a substantial premium. One may ask whether the institution of incurring the cost of such a guarantee by both parties, stated in Article 649(1) par. 3 of the Civil Code, is a kind of relief for the investor? An analysis
of case law clearly indicates that this provision provides a basis for directing a claim against a general contractor claiming to provide a payment guarantee. The claim will be for half of the costs incurred by the investor to obtain a payment guarantee, such as half of the insurance premium when an insurance product is involved. However, the investor does not have the right to demand that this cost be borne by the general contractor at the stage of obtaining a payment guarantee. To put it simply: the general contractor must fund the payment guarantee on their own, and then make a claim to the investor. This certainly raises a number of issues, both financial and practical. The legislator provided for a minimum period of 45 days in which the investor is obliged to provide an appropriate payment guarantee. However, the legislator did not symmetrically apply the obligation to reimburse half of the costs in a timely manner. Now, claiming this amount will certainly be costly and time-consuming.
The consequences of the absence of a payment guarantee, as provided by the Civil Code, are far-reaching for the investor because he cannot refuse to pay the remuneration despite the non-performance of the construction work, if the contractor (general contractor) was ready to perform it, but encountered obstacles on the part of the investor. Such would be the failure to provide a payment guarantee. In view of the above-described absolute nature of the Civil Code provisions, it is extremely important to have a far-sighted understanding of their content and consequences, and for insurers to create appropriate products. There will always be an element in them individualizing the provision of an insurance guarantee. It is clear that the investor will have to meet a number of prerequisites for obtaining such coverage, but in the current state of affairs, even the most dynamic and reliable investor may have serious problems finding insurance coverage to the extent described. However, I think that in view of the dynamic development of the real estate market, we will be able to expect the emergence of an insurance product, useful for investors in view of the obligations imposed on them.
Marta Olczak-Klimek is a legal counsellor, partner at OKW law firm, specializing in broadly defined insurance law. For more than a dozen years, she has been working with Polish and foreign insurers, brokers, claim adjusters and insurers, providing support both at the stage of concluding an insurance contract and claim settlement. She represents clients in complex civil and commercial cases of a complex nature, including those with elements of foreign legislation.