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Minimizing a contractor’s risks under a building contract

When concluding a building contract, each bona fide party to a contract has its own vision of ideal relationship in the sphere of construction. A customer considers that the construction works will be realized strictly in term, taking into account all his current and future requirements, at a price in no way higher than stipulated by the parties. A contractor, in his turn, tries to consider all customer requirements and perform properly all construction works, which are previewed and even not previewed under the contract, hoping for a subsequent payment exceeding the established price. The reality as always differs from the ideal, and usually not for the better.

Recovery of cost of works

According to the judicial practice, a contractor appears more often as an affected party.

Article 709 of the Russian Civil Code (hereinafter – Civil Code) regulates the process of conclusion of a contract of work and labor, this rule is also applicable to a building contract, which will be described hereafter. The provisions of the Article 709 of the Civil Code mainly cause problems of understanding and interpretation in law enforcement practice, that makes the relationship between the parties significantly complicated.

The judicial practice has not elaborated till present an unequivocal position whether the price constitutes an essential clause of a building contract or not. The present confusion leads to the contrary decisions adopted by the courts and different legal consequences for parties to a contract.

Paragraph 1 of the Article 709 of the Russian Civil Code prescribes, that the price of work to be performed or the methods of its determination should be stipulated in the contract. In the absence of such prescriptions in the contract, the price is determined under the rules of the paragraph 3 of the article 424 of the Civil Code.

A number of courts consider that the rules of Article 709 clearly define the price as the essential clause of the contract, and therefore recognize building contracts that do not contain the provision on price, as not concluded. Several judicial acts can illustrate this position (the Decision of the Arbitration Court of the North Caucasus District on 25.12.14 related to the case № А32-10299/2013, the Decision of the Federal Arbitration Court of the Moscow district on 25.12.12 related to the case № А40-4630/2012).

According to the Ruling of the Russian Supreme Court on 08.04.2015 № 307-ЭС15-2933 the absence of the mutually agreed price of works does not testifies that the building works were performed out of the contract, insofar as the price does not constitute the essential provision for the building contract. Besides, the second sentence of the first paragraph of the article 709 expressly authorizes to determine the price on the basis of the third paragraph of the article 424 of the Civil Code.

Under the article 7 of the Information letter of the Presidium of the Russian Supreme Arbitration Court on 25.02.2014 № 165: “in case of a dispute concerning the contract conclusion the circumstances of the case should be considered in their interconnection in favor of maintaining the obligations, rather than their cancellation, and also based on the presumption of reasonableness and good faith of participants of civil law relations, fixed in the article 10 of the Civil Code. If the parties did not agree on some clause of the contract, related to essential ones, but afterwards by joint actions on the contract performance and its acceptance eliminated the necessity to harmonize such clause, that the contract is considered as a concluded one. Presenting the result of works by a person, who has been executed them in the absence of a contract and its confirmation by a person, for whom these works have been carried out, means the conclusion of a contract by the parties. The obligations under such a contract are equal to the obligations under a contract performed by the contractor. In this case the obligations to pay the performed works as well as the guarantee of their quality arise between the parties in the same way as if they concluded the building contract initially”.

Thus, the issue of a non-conclusion of a contract due to the uncertainty of its subject or other essential provisions changes its direction in case when the contract is dully performed by the parties and the customer accepted the result of works.

From my point of view, the cost of works is not the essential term for the building contract, because the first paragraph of the article 709 prescribes the procedure for its determination in case of the absence of its indication in a contract.

Summing up, it can be stated that given the controversial judicial practice on this issue, the particular circumstances and the grounds for recognizing the building contract as a non-concluded are determinative when taking the decision on the fate of such a contract.

When recognizing the contract as a non-concluded, the question of determining the price for the work that has been already performed arises.

Depending on whether any documents on the results of the performed works were signed by the parties, the judicial practice has developed two methods for determining the price in such a situation.

In case, when a building contract for some reason was not initially concluded by the parties, or it was recognized as a non-concluded afterwards, and at the same time the act of the performed works is not signed by the customer, the cost of the performed works can be determined at a cost, which is usually charged under comparable circumstances for similar works (paragraph 3, article 424 of the Civil Code and paragraph 1 of the article 709 of the Civil Code).

In case of a non-concluded building contract, when, nevertheless, the customer signed the acts of the performed works and approved the certificates of cost of such works, the courts proceed from the fact, that the price can be determined on the basis of documents, jointly approved and signed by the parties, given the rules of unjustified enrichment.

The present conclusion is confirmed by the numerous judicial practice. (See: paragraph 6 of the Information letter of the Presidium of the Russian Arbitration Court on 25.11.2008 № 127 “Practice overview on the application of the article 10 of the Russian Civil Code by the arbitration courts”; article 8 of the Information letter of the Russian Arbitration Court on 24.01.2000 № 51 “Practice overview on dispute resolution arising under the building contract”; the Decision of the Tenth Arbitration Appellate Court on 09.12.2014 № 10АП-13140/2014, 10АП-13139/2014 on the case № А41-21494/13; the Decision of the Ninth Arbitration Appellate Court on 23.05.2014 № 09АП-13764/2014 on the case № А40-168892).

The particularities of a fixed price

It should be highlighted, that the conclusion by the parties of a building contract, indicating all the essential terms of a contract, determining the fixed contractual price does not constitute an absolute solution of all the contractor’s problems, related to the fair remuneration for the performed works.

By default, the law presumes, that the contract price is fixed, unless the parties did not specify in a contract otherwise. In accordance with the article 709 of the Civil Code, if the price under a building contract is fixed, this particular sum must be paid to the contractor for the performed works. The contractor has the right to demand the increase of the established price in case of a significant increase in costs of provided materials and equipment, and also services, rendered to the contractor by the third parties, that could not be foreseen at the moment of a contract conclusion (paragraph 6 of the article 709 of the Civil Code).

The extensive judicial practice on this issue testifies that the factual relationship between the parties do not fit in the framework of existing legislation, and as a consequence, there is a violation of a balance of interests in the present case, generally, in favor of a customer under a building contract. Very often during the course of work the amendments are being made both in an existing project and in a budget. This necessity means problems and difficulties primarily for a contractor, who either fails to perform the construction works on time due to the increase and/or changes of volumes and types of work, or fails to perform the total amount of work within the fixed price, if for some reason a customer refuses to bring the necessary changes in a building contract.

As a rule, when changing the type and the amount of construction works under the contract, the contractors do not use the method of protecting of rights, prescribed by the law – to refuse to perform the works or suspend them. The present situation occurs due to the fact, that these actions entail the risk for a contractor of not receiving the initially negotiated price, moreover, the risk of the emergence of losses when transmitting the construction site to a new contractor, as well as the solutions of the related organization matters – payment for workers, equipment leased, etc., all of this entails the infringement of a contractor’s rights and the necessity to appeal to the court.

In this way, the method of solving the dispute between the parties to a building contract proposed by the legislator is not perfect and entails numerous disputes.

For instance, in case when based on the results of its work a contractor reveals in the act of the performed works or in the certificate of the cost of works the price that differs from the fixed contractual price, the courts apply the fixed one, referring to the lack of the necessary amendments included in a building contract, as well to the absence of a notification of the customer on the increase in the cost of works or the increase of the amount of work (See, e.g.: the Ruling of the Supreme Court on 04.04.2016 № 307-ЭС16-1702, the Decision of the Tenth Arbitration Appellate Court on 23.06.2016 № 10АП-6999/16).

It is worth mentioning, that the courts, in fact, come to a conclusion that the acceptance certificates of the performed works signed by a customer confirm just the fact of the performed works, rather than the customer’s agreement on payment of the additional works or current works at a different price (paragraphs 10, 12 of the Information letter of the Presidium of the Supreme Arbitration Court on 24.01.2000 № 51 “Practice overview on disputes resolution arising under a building contract”).

If the judicial practice on the mentioned above issue has been evolving uniformly, the contractors, based at the judicial acts, could have elaborated effective approaches for solving the problem of a price change. However, there is another judicial approach, when the courts focus on the acts of the performed works and the certificates of the cost of works notwithstanding the absence of a signed additional agreement.

The present controversies in law enforcement in practice have negative effects on the results of the contractor’s activity and entail contractor’s damages.

The essence of the second approach to the problem consists in the fact, that the courts consider the certificate of the cost of works as a fundamental document defining the price to be paid to a contractor regardless of whether it exceeds the price under a building contract or it is smaller than this price. The following judicial decisions can serve as the examples of such approach: (The Decision of the Eighth Arbitration Appellate Court on 05.09.2014 N 08АП-6745/2014 on the case № А70-602/2014, The Decision of the Arbitration Court of the Volgo-Vyatskiy District on 03.03.2016 on the case А82-5955/2015, the Decision of the Arbitration Court of the Far East District on 06.03.2016 on the case А04-7110/2012, the Decision of the Arbitration Court of the Northwestern District on the case А56-36751/2015).

The courts proceed from the fact, that if the act of the performed works was signed by the parties without the remarks on quality, amount and cost of the performed works and materials used, as well as the certificate on the KS-2 form was signed, that means that the customer is satisfied with the results of work, which present for him customer value and should be dully paid.

For fairness’ sake, it should be noted, that the courts still pay close attention to the fact, whether a customer was notified by a contractor on the necessity of performing additional works, and take into account a customer’s further actions when accepting the results of work.

Nevertheless, the second approach occurs much rarer, besides, the courts tend to take into account certain predisposing factors, for instance, the specification in a contract that a customer pays for the works actually performed.

At the same time, in case, when the amount of work was reduced in comparison with the one defined in a building contract, the courts consider that the solid price can be also reduced. This approach is reflected in the Decisions of the Presidium of the Supreme Arbitration Court on 13.05.2014 № 19371/13 and on 22.04.2014 № 19891/13, that stipulate that the fixed price is determined in relation to the contractually agreed amount of work, consequently, reducing the amount of work actually performed entails a commensurate reduction in price. According to the position of the Presidium of the Arbitration Court, a different approach would be contrary to the principles of compensation of civil contracts, damaging the balance of rights and interests of the parties.

So, even if the contract contains the provision of a fixed price, it should be borne in mind, that the confirmation of amount of work actually performed corresponding to the term-sheet must be presented in order to obtain its payment. Otherwise, the price can be reduced.

The set-forth enables to state, that in case of an increase of the amount of work at a fixed price agreed by the parties to a building contract the contractor takes a risk, if the additional to the building contract agreement on the increase of a contractual price was not signed. If this case, even before the signing of the additional agreement, the contractor should necessary obtain the letters from the customer on what kind of work is really needed, and also maintain the correspondence about the price of works and obtain the customer’s consent for the additional works at the indicated price.

If the customer does not negotiate and sign the additional agreement identifying a new price in the building contract, the contractor has the right to claim in court a review of the estimate of costs, if for the reasons beyond his control the cost of works exceeded the estimate of costs by not less than 10% (paragraph 3 of the article 744 and the article 450 of the Russian Civil Code).

In case, when there are no grounds for the application of the paragraph 3 of the article 744 of the Civil Code, it will be more useful to consider several measure of the pre-trial dispute resolution, which will be described below.

The right to suspend the works

The most wide-spread problem which the contractors face with – it is the delay in the execution of counter obligations by the customer. For instance, the customer provides the building site, the equipment, technical documentation too late or delay the advance payment and so on. All of this leads to the fact, that the contractor fails to perform the works within the indicated terms.

In the objective of protection of the contractor’s interests, the cases, when the suspension of works constitutes the only possible measure, should be clearly defined.

These cases must include, first of all, the situation, defined in the article 716 of the Civil Code, according to which in case, when the contractor detects the circumstances which can damage the durability or the sustainability of the results of the work performed or make it impossible to complete it on time, the contractor is obliged to suspend the work.

In accordance with the article 719 of the Civil Code the contractor has the right not to start the works, and if the works have been already started – to suspend them in cases, when the violation by the customer of his obligations under the contract prevents the contractor from the performance of the contract, as well as under the circumstances, clearly evidencing that the execution of the prescribed obligations will not be realized at the fixed date (such circumstances may include, for example, the unavailability of construction sites, the failure to transfer the site, etc.).

In the virtue of the rules of the article 716 of the Civil Code, the contractor is obliged to immediately alert the customer and to suspend the work before receiving his instructions in case of detecting:

– the unsuitability or poor quality of materials, technical documentation, equipment or transferred for processing items, provided by the customer;

– possible unfavorable for the customer consequences of performance of its instructions about the method of executing the work;

– other circumstance laying beyond the contractor’s control, that can damage the durability or the sustainability of the results of the work performed or make it impossible to complete the work on time.

In the present situation the courts do not appreciate the contractor’s heroism and generosity, who despite the considerable difficulties, started working, on the contrary –they indicate that in such a situation the contractor loses his right to refer to a forced need for violating the terms of the performance of works or increasing the initial cost works. (See, e.g.: The Decision of the Arbitration Court of the Moscow District on 18.07.2016 on the case № А40-113995/2015, The Decision of the Arbitration Court of the Moscow District on 31.05.2016 on the case № А40-148806/2015).

To ensure the legitimacy of the contractor’s actions on the suspension of works, it is expediently even at the stage of the contract conclusion to include in the building contract the grounds for suspending the performance of works in case of the non-performance of concrete obligations of the customer: (the advance payment, the transfer of the construction site, the agreed project on the execution of works, etc.).

The next reason to suspend the works is the obligation to suspend the works in case of an absence of the customer’s response to the notification on the need to conduct the additional works.

In accordance with the paragraphs 3 and 4 of the article 743 of the Civil Code a contractor is obliged to inform a customer about any works, that he has revealed during the construction process and that were not included in a technical documentation, and, as a consequence, about the need to perform the additional works and to increase the estimated cost of construction.

In case of the absence of a customer’ response to his notification within ten days, if the law or the building contract do not stipulate another term for this, a contractor must suspend the respective works, attributing the losses, caused by the downtime, at the expense of the customer.

A contractor, who failed to perform the obligation, prescribed by the third paragraph of the article 743 of the Civil Code, loses the right to demand from the customer the payment of the additional works performed by him and the compensation for damages resulting therefrom, unless he proves the necessity of the immediate actions in the interests of the customer, particularly, related to the fact, that the suspension of works could lead to the destruction or damage of the construction facility (See, e.g.: the Ruling of the Russian Supreme Court on 21.12.2015 № 308-ЭС15-16630, the Ruling of the Russian Supreme Arbitration Court on 11.01.2011 № ВАС-17600/10).

The contractor should always bear this in mind in case, when the additional works are not agreed, properly considering the issue of risk of downtime or performance of works, not provided for by the contract.

Thus, the courts anyway proceed from the need to obtain a customer’s preliminary approval for the conduct of additional works, and in ideal – the signing of the additional agreement to the building contract, otherwise a contractor risks not to obtain an equitable remuneration on the result of his works. (See, e.g.: the Decision of the Arbitration Court of the Moscow District on 01.12.2015 on the case № А40-53475/2014, the Decision g of the Federal Arbitration Court of the Volga District on 07.05.2013 on the case № А12-13011/2012, the Decision of the Arbitration Court of the Moscow District on 18.12.2015 on the case № А40-190732/14).

In this situation, considering the presence of the customer’s prior approval for the additional works, the mere absence of the additional agreement to the building contract, does not exempt the customer from the payment of these works, if the works were accepted by the customer or present a customer value for him and he intends to use them. (See: the Decision of the Federal Arbitration Court of the Volga – Vyatka District on 12.03.2014 on the case N А39-839/2013, the Decision of the Arbitration Court of the West Siberian District on 18.09.2015 on the case № А70-1320/2014, the Decision of the Arbitration Court of the Northwest District on 21.08.2015 on the case № А21-2010/2014, the Decision of the Arbitration Court of the North Caucasus District on 08.02.2016 on the case № А32-45291/2014).

In case of the absence of the customer’s prior approval for the additional works, the courts also take into consideration the legal requirement to assess the need for immediate actions on the construction site, and, therefore, the inability to suspend the works and make an advance notification of the customer. However, in this case, it may be necessary to assign the judicial construction and technical expertise in order to establish the need for additional works, their actual volume and cost.

If in such a situation, the courts establish that the contractor had the technical possibility to notify the customer on the need for the additional works, the risks of not informing the customer are borne by the contractor.

Given the circumstances of the particular case, the facts of signing the acts on the established forms KS-2 and KS-3, the courts may assess the actions of a customer on the signing of these acts as a subsequent approval of a price increase for the additional works. (See, e.g.: the Decision of the Federal Arbitration Court of the Ural District on 20.05.2013 on the case № А60-28574/2012). However, in the majority of cases it is still necessary to obtain the approval of the additional works, before the contractor will start performing them.

It should be remembered that, in practice, the courts also apply a different approach, according to which the signing of acts is not taken into consideration. (See, e.g.: the Decision of the Federal Arbitration Court of the Moscow District on 1.04.2005 № КГ-А40/1662-05).

Besides, in all the cases of the suspension of works, it is necessary to remember that the resumption of works should be proceeded after the receipt of the corresponding letter of a customer.

In conclusion it should be noted, that in order to obtain an equitable remuneration on the results of works, the contractor should carefully and thoroughly work out the draft contract, supplement it, if needed, and weigh all the risks in detail when establishing a fixed price in a contract.

As it has been mentioned above, the additional works constitute one of the most controversial episode both in the relationship between the parties to a contract, and in the judicial practice. Due to this fact, the performance of the additional works without the prior written consent of the customer is fraught with the non-receipt of payment for them.