Questioning investor liability

The current spate of bankruptcies in the Polish construction sector is increasingly bringing into question the liability of investors towards bankrupt sub-contractors. Over 80 construction companies have been declared bankrupt over the last year and more are expected to become insolvent over the coming months. The biggest bankruptcies have been among companies involved in infrastructure projects, especially road-building contracts. Many of their problems have resulted from highly unfavourable contracts signed with the General Directorate of National Roads and Motorways (GDDKiA). The recent significant rise in the prices of building materials have revealed that the bulk of such contracts did not include the indexation clauses that would have allowed the remuneration to be respectively adjusted. As a result, the bulk of projects commissioned by the GDDKiA have been loss-making and have led construction companies into financial difficulties or even insolvency.

The current spate of bankruptcies of general contractors raises particular difficulties for private (other than GDDKiA) investors. This is due to the combination of two factors: Firstly, a great deal of the work on infrastructure projects was outsourced to sub-contractors. Secondly, under the new Polish law investors are jointly and severally liable with general contractors for the payment of remuneration to sub-contractors for the construction work performed by them. This leads to a situation where, if the general contractor goes bankrupt, the subcontractors whose work has not been paid for by the bankrupt contractor are entitled to demand payment directly from the investors.

Once the general contractor's bankruptcy has been announced, its estate constitutes the bankruptcy estate, and so a trustee (or receiver, depending on the type of bankruptcy) is appointed to - among other duties - collect all the receivables of the bankrupt party. On the one hand, the investor is obliged under the agreement with the bankrupt party to make payments to the bankruptcy trustee (receiver). On the other hand, however, the sub-contractors are entitled to demand that the payment is made directly to them. In the case that such an investor pays the remuneration directly to a sub-contractor, it may have recourse to the trustee (receiver) for the amount paid to the sub-contractor. This would, however, be included in the list of creditors and satisfied from the bankruptcy estate according to the bankruptcy regime. As a result, such claims would be very unlikely to be satisfied up to the entire amount demanded.

The issue of bankruptcies in the construction sector is the current subject of heated debate in Poland. Some blame the GDDKiA for signing contracts on terms too harsh for construction companies and based on unrealistic assumptions. This, however, has been rebutted by GDDKiA's reasonable retort that nobody was forced to enter into the contracts in the first place.

A number of resolutions for these GDDKiA contracts are now being negotiated and have been taken to the parliamentary and governmental levels. Hopefully this will, over the next few months, turn out to be a helping hand to construction companies facing financial difficulties. The discussed options are not, however, likely to solve the other, in fact, more significant problem - the need for higher protection for investors, who are currently unjustifiably exposed to the risk of general contractor bankruptcy.

Before the law is amended in this respect, it would be advisable to minimise the risk of exposure to the existing legal measures. In particular, special clauses should be included in construction contracts, broadening the scope of the investors' rights in the case of their contractors' insolvency. With respect to the contracts already executed, investors are advised to verify them and assess whether the mechanisms used provide sufficient protection against the contractors' insolvency, as well as to introduce a system of managing the contract's fulfilment by the general contractor and its sub-contractors.

Małgorzata Chruściak (top), partner, and head of banking and international ?finance; and Agnieszka Ziółek, senior associate in the banking and international finance department of the Warsaw office of CMS Cameron McKenna