Investor’s situation under construction contracts during an epidemic | In Principle

Many investors currently carrying out construction projects or planning to start them in the near future ask us about the legal possibilities to suspend a project or even withdraw from existing contracts. The question arises whether it makes sense to continue or start projects when implementation will require large financial capital and considerable resources. In this article, we identify legal instruments that may be available to an investor who would decide to stop the performance of works or definitively withdraw from a construction contract.

This article is devoted exclusively to contracts concluded on the basis of the Polish Civil Code. Therefore, we do not analyse contracts concluded under FIDIC conditions of contract or the public procurement regime.

If there is a force majeure clause in the contract

Practice shows that many construction contracts performed under the Civil Code regime contain provisions regulating issues related to force majeure and the obligations of the parties in the event of its occurrence. These clauses have often been borrowed from foreign contractual templates.

The concept of force majeure is defined in various manners in contracts: sometimes in a general way, as an unforeseeable external event whose consequences the parties cannot prevent; sometimes, events treated as force majeure are enumerated, such as natural phenomena (flood, hurricane, earthquake), war, riots, strikes and, frequently, epidemics.

In most cases, the occurrence of force majeure is treated by the parties in contracts as a basis for releasing them from liability for non-performance or improper performance of obligations as a result of force majeure (e.g. delay in performance of works).

These contractual provisions may also serve the investor as a defence in a situation where, as a result of an epidemic, it loses the possibility of obtaining the financing necessary to carry out the project, resulting in the inability to meet the obligations arising from the contract. Banks will now take a more restrictive approach in assessing borrowers’ creditworthiness. In addition, due to the pandemic, the investor may have difficulties obtaining a building permit within the contractually required deadline (if any).  In such situations, depending on the stage of works, the investor would have a right to withhold handover of the construction site to the contractor or to suspend the works for the duration of the epidemic.

Contracts often provide for the right of either party, or the party affected by a force majeure event, to withdraw from the contract if the event exceeds a period specified in the contract. The contract may also specify the settlement method for works performed so far by the contractor.

The legal analysis of the investor’s situation should in any event take account of the provisions of the agreement, which may resolve the situation caused by the epidemic.

If there is no force majeure clause in the contract

What if the parties have not regulated the consequences of an epidemic in the contract? Then, reference should be made to existing legislation and case law.

• Force majeure under the Civil Code and undue performance of the contract

   

There is no definition of force majeure in the Civil Code, although there are several references to this concept. There is a well-established view in the decisions of the Supreme Court of Poland that force majeure can exist only if damage was caused by an extraordinary and unexpected external event which could not have been prevented by normal security measures. Thus, in this sense, the COVID-19 pandemic may constitute a force majeure event, and the event will greatly impact acts or omissions of a party to the contract. Under the general principle expressed in Art. 471 of the Civil Code, the obligor is liable for culpable non-performance or improper performance of the contract. This means that the obligor is not liable if failure to perform is not the obligor’s fault. Liability will be excluded due to force majeure if, among other things, there is a causal relationship between the force majeure event and non-performance of the obligation.

With reference to the situation described above, where due to the pandemic the investor has lost its source of financing and even with due diligence cannot obtain it in any other way, in our opinion the investor may invoke force majeure if the contractor demands payment of compensation for refusal to hand over the construction site or generally to refuse further construction works.

• Withdrawing from the contract before the end of work

In any case, as long as the construction works are not performed, the investor is entitled to withdraw from the contract in accordance with Art. 644 of the Civil Code. However, in this case, it must pay the agreed fee, deducting what the contractor has saved due to non-performance of the work. Therefore, in this scenario, the fee can be reduced by the value of unpurchased materials and labour saved.

• Delay in works

The investor also has a right under Art. 635 of the Civil Code to withdraw from a contract for construction works, without setting an additional deadline, if the contractor delays commencement or completion of works to such an extent that it is unlikely it will manage to complete them within the agreed time. The legal literature indicates that the reasons for the contractor to delay performance of works is irrelevant. It is only necessary that these reasons do not lie with the investor. This solution is more advantageous to the investor than the right specified in Art. 644 of the code, taking into account mutual settlements of the parties to the agreement.

• Extraordinary change in circumstances

   

We cannot overlook the power to request a court to shape a contractual relationship, discussed several times by us on the site, and even the power to demand termination of the contract if, as a result of an extraordinary change in circumstances, performance of the construction contract threatens the investor with a glaring loss or entails excessive difficulties which the parties did not foresee when concluding the contract.

The COVID-19 pandemic and all its consequences may qualify as an extraordinary change in circumstances, and depending on the specific contract and the facts, the investor may be able to demonstrate an irreparable loss, in particular taking into account such circumstances as statutory bans and restrictions on commercial activity and the related difficulties in commercialising the built space. This refers to owners of new shopping centres under construction who, due to statutory bans on certain commercial activities, will not be able to receive rent from tenants for the duration of the epidemic, and perhaps even longer.

According to the Warsaw Court of Appeal judgment of 25 September 2013 (case no. VI ACa 71/13), an extraordinary change in circumstances means a state of affairs that happens rarely, and is unusual, uncommon, exceptional, and typically unprecedented. In that case, the court stated that an extraordinary change in circumstances may have a natural background (crop failure, an extremely harsh winter), or a social background (war, rapid change of the political system). Moreover, epidemics, military operations, general strikes, various types of natural disasters, extraordinary and profound changes in the economic situation, manifested by hyperinflation, a sharp drop in national income or massive business bankruptcies, but also unexpected changes in customs or tax rates, are all cited as examples of events causing an extraordinary change in circumstances.

• Subsequent impossibility of performance

It is also worth considering subsequent impossibility of performance in relation to the investor’s situation, as specified in Art. 475 of the Civil Code. The amendment to the Anti-Crisis Act, known as the “Anti-Crisis Shield,” which entered into force on 31 March 2020, provides for suspension of the running of time limits for administrative proceedings for the duration of the epidemic, a regulation that may result in the investor’s inability to obtain a construction permit within the originally assumed period. In such a situation, the investor will have arguments for asserting the subsequent impossibility of performance.

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It should be stressed that the parties may agree to modify or even exclude the statutory instruments described above, so the final analysis of the investor’s legal situation must always take into account the provisions of the specific agreement.

The situation related to the coronavirus epidemic is extremely dynamic. We do not know what further restrictions and bans the parliament will introduce in relation to movement of persons and exercise of economic activity, and how it will change the existing restrictions. Certainly this article does not exhaust the subject, but only indicates some instruments investors may be able to use in these difficult times.

Sylwia Moreu-Żak, attorney-at-law, Construction practice, Wardyński & Partners