When preparing contract documents, the contracting authority must decide the amount of the performance bond it will demand. As a rule, this security should amount to 5% of the total bid price or the value of the contracting authority’s liability. But when can this threshold be exceeded, and to what maximum value? This and other questions were answered in the ruling of the National Appeal Chamber of 21 October 2020 (KIO 1381/20).
State of facts
In the terms of reference for a road construction project in Poland, the contracting authority included a provision stating that the performance bond was to amount to 10% of the contract value. It did not give any reasons for its decision to exceed the 5% threshold. Therefore, one of the contractors participating in the procedure filed an appeal with the National Appeal Chamber (KIO) challenging the legitimacy of the established amount of the security and requesting that it be reduced to 5%.
It was only in the response to the appeal that the contracting authority provided a justification for its decision, indicating that the project had to be connected as soon as possible to the existing section of the expressway. Additionally, it pointed out that the contract would be co-financed with funds from the European Union, and therefore it was appropriate to safeguard against unauthorised acts by the contractor which would lead to unfavourable financial corrections. But the appellant was unconvinced, and continued to press its allegations.
Exception to the rule, i.e. when the contracting authority may demand 10% security
Pursuant to Art. 452(2) of the new Public Procurement Law, security should be established in an amount not exceeding 5% of the total price specified in the bid or the maximum nominal value of the contracting authority’s liability under the contract. However, Art. 452(3) allows the contracting authority to increase the amount of security under certain conditions. Thus the security may be set at an amount above 5%, but no higher than 10%, if justified by the subject matter of the contract or the existence of risk connected with performance of the contract, as described by the contracting authority in the terms of reference or other contract documents.
It follows that requiring security not exceeding the 5% threshold does not require justification, and is a sovereign right of the contracting authority. The difficulties begin only when the contracting authority intends to establish security of a higher amount, which requires that two conditions both be met:
- Higher security must result from the specifics of the subject matter of the contract or the risk involved in performing the contract.
- This justification must be provided by the contracting authority in the terms of reference or other contract documents.
As the chamber pointed out in its ruling, “The first condition is of a substantive nature, as it results from the specificity of the subject matter or the risk related to contract performance, which demands increased security for correct contract performance or to redress potential losses and cure defects. The second condition imposes a formal requirement on the contracting authority to include a justification for requesting a higher amount of security in the terms of reference or other contract documents.”
Only when these two conditions are met at the same time will the contracting authority be able to establish security in an amount exceeding 5%. However, while the first condition is objective and does not depend on the will of the contracting authority, fulfilment of the second condition depends on the correct action of the contracting authority, which is obliged to provide a sufficient justification for its decision.
The burden of proof lies with the contracting authority
Pursuant to the rules of evidence in force in appeal proceedings, the burden of proof will rest with the contracting authority, which derives legal effect from its statements in the form of a request for a higher security. It is the responsibility of the contracting authority to show that the reasons for requiring 10% security are justified by the subject matter of the contract or the risks associated with its performance.
Additionally, the chamber observed: “The act does not indicate exclusively two security thresholds of 5% and 10%, but gives the contracting authority the possibility to set it at an appropriate amount, subject to justification if the 5% value is exceeded. Therefore, the burden of proof of the contracting authority involves two elements: exceeding the 5% threshold and setting a value in the range from 6% to 10%.”
Therefore, having regard to Art. 452(3) of the new Public Procurement Law, the contracting authority will have to prove the need to exceed the 5% threshold and demonstrate why it set the security at a specific value.
The burden of proof lies with the contracting authority solely at the stage of the public procurement procedure, as the circumstances supporting higher security should be described in the terms of reference or other contract documents. Failure to comply with this obligation has very negative consequences. The chamber pointed out in its ruling that at the stage of appeal proceedings, the contracting authority cannot provide a justification that was not included in the contract documents or go beyond the boundaries set out in the terms of reference.
As a result, the arguments put forward by the contracting authority in its response to the appeal were too late and had no legal merit. Nonetheless, it is worth reviewing them to determine what direction other contracting authorities should take when formulating contract documentation.
The justification should refer to the subject matter of the contract and not to the time limit for its performance
The explanations given by the contracting authority in this case tied the amount of the security to timely execution of the contract (due to the need to connect the road in question to an existing section) and co-financing from European funds. However, the chamber rejected this way of justifying a higher amount of security. It stressed that the mere need to execute the contract in the shortest possible time is not a sufficient justification for demanding security in the maximum amount provided for by the act, as the act clearly distinguishes the subject matter of the public contract, as a separate legal category, from the deadline for its performance. According to the chamber, “Art. 452(3) of the Public Procurement Law refers only to the subject matter of the contract and does not cover issues related to the time limit for its performance. As a result, it is in the specifics of the subject matter of the contract, its complexity and special circumstances, and not the deadline for performance of the contract, where justification for increasing the security should be sought.”
The same applies to the second argument, i.e. the risk of losing the EU funding for the project. Also in this case, the contracting authority did not refer to the subject matter of the contract, but to other, indirectly related circumstances. However, the chamber also pointed out that in such a case the contracting authority should initiate the contract award procedure early enough so that timely disbursement of the EU funding is not threatened. This is because the question of settling the accounts of the contracting authority with the financing institution does not directly concern the contractual relationship between the contracting authority and the contractor, and thus is not directly related to the subject matter of the contract or the risk associated with its performance. It concerns the relationship between the contracting authority and the financing institution, which a not a party to the contract.
A lesson learned
In the procurement discussed here, the contracting authority made two glaring errors. First, instead of formulating the justification for the higher value of the security in the terms of reference or other contract documents, it provided explanations only in the appeal proceedings, in its response to the appeal. Second, the arguments invoked by it were related not to the subject matter of the contract, but to timely performance, which is contrary to Art. 452(3) of the law. As a result, the National Appeal Chamber ordered removal of the disputed provision from the terms of reference and entrusted the issue of determining the precise amount of the security to the contracting authority.
Cyprian Herl, Infrastructure, Transport, Public Procurement & PPP Practice, Wardyński & Partners