Modification of contracts and contractual penalties in public contracts in the face of the pandemic | In Principle

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Modification of contracts and contractual penalties in public contracts in the face of the pandemic

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 Anti-Crisis Act comes to their aid.

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 procurement contracts, i.e. for supplies, services, and construction works.

What contracts does the Anti-Crisis Act apply to?

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, and also whether the boundary date should be set at entry into force of the Anti-Crisis Act (8 March 2020) or the amending act (31 March 2020). 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. The act provides added value only if it is interpreted in this way.

This is because this provision adds nothing to contracts concluded before the pandemic, but only repeats the possibilities already provided for by Art. 144(1)(3) of the Public Procurement Law since it has been in force. But with respect to contracts concluded during the pandemic, the provisions of the Anti-Crisis Act will be helpful, as they confirm that even in their case Art. 144(1)(3) is applicable, even though it refers to “circumstances which the contracting authority, acting with due diligence, could not have foreseen.” The Anti-Crisis Act stipulates that the pandemic is such a circumstance, even though the contracting authority knew of it when concluding the contract. The act thus provides a kind of interpretation of Art. 144(1)(3) made by the parliament to facilitate application of this provision under these circumstances.

This top-down statutory interpretation is particularly helpful for contracting authorities now conducting a procedure for award of a contract or intending to launch one. Unlike private contracting entities, who are not subject to the Public Procurement Law and are not covered by this regulation, they need not address in their contracts the impact of the pandemic on performance of contracts and the relations and arrangements between the parties, as the parliament has done this for them across the board.

This approach is also justified to some degree by the course of procurement procedures. Contracting authorities will not have to adjust the documentation of procedures planned or underway to reflect the current conditions, which would require additional legal support (introducing appropriate legal solutions in specific contract award procedures).

Duty to report on impact of COVID-19 epidemic on contract performance

The basis for 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 preceded by 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 issued by province governors or decisions by the Prime Minister connected with combating COVID-19 referred to in Art. 11(1)–(2) of the act (compulsory conclusion of contract)
  • Breakdown of the supply chain
  • Similar circumstances affecting subcontractors or sub-subcontractors.

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 stressed 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 stressed 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) 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.

If the contracting authority finds that circumstances connected with COVID-19 are affecting or could affect due performance of the contract, it may 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.

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.

Additionally, the act provides that if the public contract contains provisions more favourably framing the situation of the contractor than would arise under the Anti-Crisis Act, those provisions will apply to modifications of the contract. But the act also provides that circumstances related to occurrence of COVID-19 cannot constitute a sufficient basis on their own to exercise a contractual right to renounce 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.

Arbitrary decision of contracting authority

The rules for permissible changes to contracts discussed above have one serious flaw, however, namely the contracting authority’s discretion in deciding on modification of the public contract. The fact that modification is optional even if the pandemic is found to impact performance of the contract is widely criticised. Effectively, as under Art. 144(1)(3) of the Public Procurement Law, here too the contracting authority may modify the contract but does not have to do so.

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, “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 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.

As mentioned earlier, this aspect of the Anti-Crisis Act will play a particularly important role with respect to contracts concluded after the occurrence of external circumstances resulting from the spread of the SARS-CoV-2 virus. This is because the act interprets the current situation as independent, external and not attributable to either of the parties. This interpretation has far-reaching significance, as under general principles of civil law, conclusion of new contracts during the coronavirus pandemic and at a time when various extraordinary administrative measures are in force could limit or exclude a party’s ability to invoke standard contractual provisions involving force majeure.

Conclusion of a contract under the current conditions could also be regarded in some circumstances as imprudent, thus depriving the party of legal protection in the future. It could be alleged that a prudent business should foresee difficulties connected with the current situation and take them into account when assuming new obligations, ensuring that they can fulfil them.

In new contracts not governed by the Public Procurement Law, it is recommended to include provisions addressing the potential inability to perform contractual obligations due to the coronavirus. But in the case of public procurement contracts, the parliament has stepped in. The Anti-Crisis Act frees contracting authorities from the need to examine the Civil Code and gives them clear guidance on what concessions to contractors are lawful in light of the current situation. It is also helpful that the Anti-Crisis Act expressly excludes liability under public finance discipline or the Criminal Code, and also excludes an allegation of mismanagement when applying the procedures provided for in the Anti-Crisis Act (Art. 15s–15u). This provision should expedite the decision-making process on the part of contracting authorities, ensure them the flexibility they need, and encourage them to exercise the possibilities provided by the act.

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.

Dr Hanna Drynkorn, Cyprian Herl, Infrastructure, Transport, Public Procurement & PPP practice, Wardyński & Partners