What fee model to use in construction contracts? | In Principle

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What fee model to use in construction contracts?

The choice of a fee model is a key element of any contract for construction works. In market practice, several mechanisms are in place for determining the payment method, each of which has its advantages and disadvantages. The chosen fee model should correspond to the specifics and scope of work and take into account the interests of both parties to the contract.

When discussing the type of fee in contracts for construction works in Poland, it is important to note the lack of top-down regulations in this area. Although the contractor’s fee is one of the key aspects of the construction process, the regulations only impose on the investor an obligation to pay the fee, not a method of calculation.

This results in a certain amount of leeway under the principle of freedom of contract (Civil Code Art. 3531). Typically, a contract to produce a work (umowa o dzieło) or a contract for construction works will take one of two fee forms governed by the Civil Code: a flat fee, regulated by Art. 632, or a cost-estimate-based fee, regulated by Art. 629.

Flat fee

The flat-fee model involves setting the total fee in advance, so that the investor has almost certain knowledge from the time the contract is concluded of what amount it will be obliged to pay the contractor for performing the specified works. Under Civil Code Art. 629 §1, if the parties have agreed on a flat fee, the contractor cannot demand an increase of the fee, even if the size or cost of the work could not have been foreseen at the time of signing the contract. This rule does not apply to works that were not commissioned by the investor or go beyond the agreed scope of works.

This fee model is favoured by investors and banks financing projects that want to have control over the expenses associated with the project. For the contractor, however, this model carries some risk. If at the initial stage the contractor does not take into account all the activities or materials necessary for performance of the contract, or as a result of external circumstances the cost of performing the contract increases within the limits that should reasonably be taken into account by a contractor acting with due care, in principle the contractor will not be entitled to demand a fee increase.

Some legal mechanisms do exist, i.e. Art. 3571 and Art. 632 §2 of the Civil Code, allowing the contractor to request a fee increase, particularly as a result of an unforeseen increase in the price of materials or occurrence of circumstances that could not have been foreseen when signing the contract. But such situations are still exceptions to the rule dictated by the statute and require the contractor to meet additional conditions (e.g. to demonstrate that it is threatened with a loss).

Cost-estimate-based fee

In contracts for construction works, the second standard fee model is based on a cost estimate. It is determined based on the specification of planned work and the expected cost of necessary materials (Civil Code Art. 629), as well as other direct costs, overheads, and a profit margin.

In this model, the final amount of the fee is usually determined based on the actual scope of work completed and the rates established in the cost estimate. The case law indicates that the cost estimate should be prepared before or at the conclusion of the contract, not after performance, and there is no obligation on either party to the contract to prepare an as-built cost estimate. The cost-estimate approach is more often used for complex, multi-phase projects.

Mixed fee

If the parties to a contract for construction works cannot agree on the method for paying the contractor, or neither of the foregoing models suits their interests, a compromise may appear in the form of a mixed fee. A mixed fee can take any form, with the predominant features of a flat fee or a cost-estimate-based fee.

Such a method of determining the fee has developed in practice. As the parliament has left the parties to a contract for construction works the freedom to choose the fee form, they began to create their own models, drawing in part on regulations on flat fees and in part on cost-estimate-based fees.

The way the fee is usually calculated in the mixed model is that the contractor, as in the case of a cost-estimate-based fee, prepares a specification of works and a cost estimate, including the cost of materials, based on which the parties determine the amount of the fee, while stipulating that it cannot exceed a certain cap, which in turn is characteristic of a flat fee.

The question arises of the extent to which the provisions governing the cost-estimate-based fee and the flat fee, Art. 629 and 632 of the Civil Code respectively, apply to the mixed fee model. After all, these provisions impose significant limitations when using the two indicated models. In the judgment of 15 December 2021 (case no. III CSKP 127/21), the Supreme Court of Poland held that clauses of a contract for construction works (alternatively a contract to perform a work) take precedence over the solutions provided in the Civil Code:

“The parties to the contract may use either of the fee models (provided for in the Civil Code), but they may also agree on another way of determining the fee, i.e. a mixed model. On this subject, the parties have fairly wide freedom, so they can agree, for example, that the flat rate refers to the works included in the contract, while any additional works will be paid based on a cost estimate, or there may be a cost-estimate-based fee as part of a flat fee (thus the contractor will be due a fee calculated after completion of the works on the basis of the cost estimate, but the fee cannot exceed a predetermined amount).”

In such a case, the application of Art. 629 will be limited, because taking into account the changed amount of prices or rates adopted for cost-estimate calculations cannot lead to calculation of the fee in excess of an established level (E. Gniewek & P. Machnikowski (eds.), Civil Code: Commentary (11th ed., Warsaw 2023)). If, however, the conditions under Art. 632 §2 are met, i.e. due to a change in circumstances which could not have been foreseen, the performance of a specific work exposes the contractor to a glaring loss, the court may increase the flat rate fee or terminate the contract.

Like the codified models, mixed models should meet certain conditions. First, the rules for determining the fee must be transparent and clearly defined in the contract. The parties should indicate exactly what criteria will be taken into account in determining the fee and what the consequences of not meeting these criteria will be.

In a contract for construction works, it is permissible to determine the fee based on quality, time, quantity or other parameters that affect achievement of the intended results. However, it is essential that such criteria can be measured and verified during the term of the contract.

Regardless of the chosen model, the parties are obliged to cooperate and inform each other of any changes in the conditions that may affect the fee.

Which fee model should be chosen?

When choosing a fee model in a contract for construction works, the parties should be guided primarily by the size and complexity of the construction project, while taking into account as far as possible the market conditions in which the contract will be performed. The flat fee will be a risky choice for construction works with a material scope that is difficult to determine. But in the case of construction works performed under the public procurement regime, such as large rail or road projects or waste incineration plants, this will be the only fee model allowed by the contracting authority.

The cost-estimate-based fee can be advantageous to the contractor if there is substantial uncertainty regarding the scope of works, or the contractor is required to design the project and then build it.

On the other hand, a mixed fee can be advantageous when, at the outset, some elements of the project are well-defined while others are uncertain and will become clearer in the future. Additionally, as confirmed by the Supreme Court in its judgment of 25 March 2015 (case no. II CSK 389/14), in a mixed model, it is possible to reduce the fee if the investor abandons certain works.

When choosing a fee model in a contract for construction works, the key criterion should be safeguarding the interests of both parties. It is important that the parties, especially those represented by professional advisors, precisely define the fee model to avoid future disputes in this regard.

The decision on the choice of the fee model should always be made on a case-by-case basis, taking into account the specifics of the project. In any case, it is crucial to thoroughly understand the terms and conditions of the contract and the potential risks associated with the choice of a particular fee model.

Sylwia Moreu-Żak, attorney-at-law, Aleksandra Szczepińska, Real Estate practice, Wardyński & Partners