How not to pay twice for one development

The risks from liability incurred in the implementation of construction contracts can pose a serious problem to the parties concerned. A step-by-step guide on how to draw up agreements to minimize the problem

Under Polish law, the parties to a construction contract – let’s call them the employer (although in Poland this is a little misleadingly referred to as the ‘investor’) and the contractor – are jointly and severally liable for paying for work carried out by subcontractors, including further subcontractors. It is possible that the employer may be obliged to pay twice for the same construction work, firstly to the contractor, and, if the contractor fails to pay the subcontractors, also directly to the subcontractors. The statutory concept in Polish law whereby an employer who is not a party to contracts with subcontractors, is still directly liable to them, remains controversial.

It is common in development projects for the owner of a property to enter into a development agreement with a developer. The developer then enters into a construction contract with a general contractor, and the general contractor enters into construction contracts with subcontractors. As it is the developer, rather than the property owner, that enters into a contract with the general contractor, it might seem that only the developer and the general contractor are jointly and severally liable towards subcontractors.

Special treatment for subcontractors

However, Polish court decisions tend to treat the protection of subcontractors as a priority, to the detriment of all the other entities involved in the project. A number of court decisions have been issued that treat development contracts as construction contracts, property owners as investors, developers as general contractors, general contractors as subcontractors and subcontractors as further subcontractors.

As a result, property owners who have engaged developers are liable, jointly and severally, with such developers for paying the general contractor and the subcontractors, despite the fact that such owners did not enter into construction contracts themselves. Problems may arise even after a building or facility has been completed. We have recently been involved in a case where one year after a building was completed, subcontractors raised claims against the developer and the owner for so-called ‘additional work’ that was not covered by the original construction contract. Such claims may be an unpleasant surprise, for example, for a fund that has purchased a company with an interest in a commercial property for a purchase price calculated based on the assumption that the target company did not run the risk of any payments to the general contractor or subcontractors.

The parties to a construction contract cannot avoid statutory joint and several liability towards subcontractors. However, there are certain contracting techniques that may be applied to minimize the risk of that liability arising or its negative effects if it arises.

Watch that ladder!

Firstly, it is advisable to carefully regulate in the contract the terms of co-operation between the owner, the developer and the general contractor over the process of selecting subcontractors and further subcontractors, so that the parties may jointly monitor the process of making payments at different steps of the payment ‘ladder’, and so that it is possible to immediately suspend further payments, if arrears arise at any step of the ‘ladder’.

Secondly, particular attention should be paid to correlating the dates of payment for the same stages of the work at particular steps of the payment ‘ladder’. The terms of the contracts should make it easy for the owner and the developer to identify, as quickly as possible, a situation where arrears appear in the payments due to subcontractors or indirect subcontractors. Such contracts should also enable the suspension of further payments at higher levels of the payment ‘ladder’ until the arrears at the lower levels have been settled. The risk for the owner and the developer is lower if the date of payment to subcontractors for a given stage of the work falls before the date of payment to the general contractor for the same stage.

Thirdly, indemnities between all entities involved in the project and related security instruments should be regulated very carefully, specifically as regards their periods and restrictions on amounts. If there is a risk that a subcontractor may raise statutory claims directly against the property owner, that subcontractor should at the same time be liable towards the owner for delays or defects in the work it has carried out. Currently the statutory regulation does not provide for such liability. This issue needs to be regulated in the contracts between the parties involved.

A contractual regulation should make it possible to effectively bring claims against the entity whose default triggered the arrears, as well as protect entities which, through no contractual default of their own, might be held liable under the controversial Polish statutory regulations.

Tomasz Kurek (left), partner  – head of real estate and construction department

Wojciech Szybkowski, partner – real estate and construction department

CMS Cameron McKenna