Construction Contract Related Risks and Disputes

Nikolay Andrianov, Partner, Exiora Law Firm, Moscow

Traditionally, construction related disputes have formed the bulk of cases heard by Russian courts. Such disputes primarily concern payment for works performed by the contractor, the customer’s claims as to the quality of the works or performance dates. Court practice pertaining to construction disputes is quite extensive, however, the growing number of cases tried by courts evidences that when entering into and performing construction contracts the parties do not fully assess their legal risks as they should.

Contract Price

Russian laws do not consider the price to be an essential term of a construction contract. If, when entering into a contract, the parties do not agree on the price, payment, pursuant to Paragraph 3, Article 424 of the Russian Civil Code (the “Russian Civil Code”), must be made at the price which is normally charged for similar works under comparable circumstances. If the contract price is agreed on, then, under Paragraph 1, Article 424 of the Russian Civil Code, payment must be made at this price.

Pursuant to Paragraph 3, Article 709 of the Russian Civil Code, the price of work may be determined by making a cost estimate. If the work is performed following a cost estimate made by the contractor, such cost estimate becomes effective and forms part of the construction contract from the date when it is approved by the customer. The cost estimate constitutes a detailed and itemized calculation of the contract price reflecting the cost of each separate work, materials and equipment used in performing it, and other costs.

Under Paragraph 4, Article 709 of the Russian Civil Code, the price of works (cost estimate) may either be an approximation or a fixed figure. In the absence of any mentioning to the contrary, the price of works is deemed to be fixed.

The legal meaning of the terms of a construction contract with regard to the fixed price is revealed in Paragraph 6, Article 709 of the Russian Civil Code, pursuant to which the contractor may not claim to increase the fixed price, and the customer – to decrease it, including in situations where, when entering into a construction contract, the possibility to foresee the full scope of works to be performed or required costs is excluded. The only exception is made for cases of a significant appreciation in the cost of materials and equipment supplied by the contractor and services rendered to it by third parties which fact could not be foreseen when concluding the contract, where the contractor, by virtue of Subparagraph 2, Paragraph 6, Article 709 of the Russian Civil Code, may claim to increase the set price, and if the customer refuses to do so, terminate the construction contract following the provisions of Article 451 of the Russian Civil Code.

Thus, the practical purpose behind setting a fixed contract price is to protect the customer from any potential risks related to the increase of the cost of construction works due to, in particular, the growth of the works to be performed in terms of their scope. That is, the fixed price within the meaning of Paragraph 6, Article 709 of the Russian Civil Code is payable by the customer for the overall result of the works, regardless of the scope of works which the contractor had to perform to achieve the said result (including any additional works). Any extra costs incurred by the contractor related to the increase in the scope of works which were not provided for when signing the construction contract are to be covered by the contractor’s consideration (Paragraph 2, Article 709 of the Russian Civil Code).

If the price at which the contract is entered into is an approximation, the contractor, under Paragraph 5, Article 709 of the Russian Civil Code, must in a timely manner inform the customer of the need to perform additional works entailing a significant appreciation in the approximate price of works. If the customer does not agree to such appreciation, Paragraph 5 Article 709 of the Russian Civil Code entitles it to waive the contract by paying the contractor the cost of the actually performed works.

If the contractor fails to notify the customer in a timely manner of the necessity to exceed the estimated price of the works specified when signing the contract, the former, pursuant to Subparagraph 2, Paragraph 5, Article 709 of the Russian Civil Code, is obliged to perform the contract (i.e., deliver to the customer the result of the works which specifications were agreed on when entering into the contract), while reserving the right to be paid for the works at the initially determined contract price.

Apparently, when signing the contract at a fixed price, the contractor assumes the risks related to a potential appreciation of construction works owing to the fact that the scope of the actually performed works is more than was agreed on when the contract was made. In this regard, typically, the price clause of the contract would provide for a reserve for unforeseen works and expenses.

The contractor’s risks related to the potential appreciation of construction works in situations where the contract specifies a fixed contract price are compensated by absence with the customer, pursuant to Subparagraph 2, Paragraph 6, Article 709 of the Russian Civil Code, of the right to claim a decrease in the contract price if the scope of the actually performed works is less than that mentioned when signing the contract. In such cases the contractor’s consideration for the works would be more due to its reduced costs (Paragraph 2, Article 709 of the Russian Civil Code).

The existing court practice is nonetheless not that consistent. In 2014, the Presidium of the Supreme Commercial Arbitration Court of the Russian Federation issued two resolutions (No. 19371/13 dated May 13, 2014 and No. 19891/13 dated April 22, 2014) containing its legal view following which the price of a construction contract is determined based on the scope of works agreed on in the contract, and due to that a reduction in the scope of works entails a proportionate reduction in the contract price. In other words, if under a contract entered into on a fixed price basis the scope of the works performed by the contract is less than that specified when the contract was signed, the contractor is only entitled to claim payment for the actually performed works. A different approach would, in the view of the Presidium of the Supreme Commercial Arbitration Court, contradict the consideration requirement for civil contracts and would thus distort the balance of rights and interests of the parties.

Despite the fact that both resolutions were issued by the Presidium of the Supreme Commercial Arbitration Court on disputes arising from state procurement contracts, these legal propositions may also be applied by courts when resolving purely commercial disputes.

Delivery and Acceptance and Payment for Works Performed

According to explanations contained in Section 8 of the News Letter of the Presidium of the Supreme Commercial Arbitration Court of the Russian Federation dated January 24, 2000 No. 51, the grounds for occurrence with the customer of the obligation to pay for performed works is the fact of their delivery by the contractor. Subsequently, the Presidium of the Supreme Commercial Arbitration Court of the Russian Federation have on many occasions confirmed such approach (see Resolutions of the Presidium of the Supreme Commercial Arbitration Court of the Russian Federation dated March 09, 2011 No. 13765/10, dated July 27, 2011 No. 2918/11, dated July 23, 2013 No 4030/13), noting that the risks related to non-performance of the obligation to arrange for and exercise the acceptance of works are borne, by default, by the customer (Resolution of the Presidium of the Supreme Commercial Arbitration Court of the Russian Federation dated December 03, 2013 No. 10147/13).

Under Paragraph 1, Article 753 of the Russian Civil Code, the customer notified by the contractor of its readiness to deliver the works performed under a construction contract in general or, if the contract provides for such an option, the works performed within a certain stage of construction, must immediately proceed to their acceptance.

It flows from the provisions of Paragraph 2, Article 753 of the Russian Civil Code that the customer arranges for and exercises the acceptance of the works at its own expense, save for the situations where the construction contract provides for otherwise.

Pursuant to Paragraph 4, Article 753 of the Russian Civil Code, the delivery of works by the contractor and their acceptance by the customer is formalized by a delivery and acceptance certificate to be signed by both parties.

The Presidium of the Supreme Commercial Arbitration Court of the Russian Federation in its Resolution dated October 09, 2012 No. 5150/12 specified that the delivery and acceptance certificate for works performed evidences the fact of the contractor’s delivery of the result of the works performed to the customer.

The Supreme Court, in its Ruling dated June 29, 2015 No. 303-ЭС15-369, noted that pursuant to Article 65 of the Arbitration Procedure Code of the Russian Federation, the obligation to document the fact of the performance and delivery of works is on the contractor.

In order to further develop this legal proposition, the Supreme Court, in its Ruling dated August 24, 2015 No. 302-ЭС15-8288 clarified that the contractor claiming the collection of the customer’s debt related to payment for the works performed, to be able to prove the performance of its respective obligations, must produce evidence of its notifying the customer of its readiness to deliver the works performed and a delivery and acceptance certificate for the works performed, and in Ruling dated February  09, 2015 No. 309-ЭС14-1949, the Supreme Court specified that the fact of the contractor’s delivery of the works performed must be specifically evidenced by a delivery and acceptance certificate, and dismissed as evidence a certificate of audit of contract performance which does not constitute a delivery and acceptance certificate within the meaning attached to it by Articles 720, 753 of the Russian Civil Code.

Oftentimes, customers that reveal defects in works in the course of acceptance refer to them and refuse to sign a delivery and acceptance certificate in their belief that, before they accept the works, the contractor is not entitled to claim payment for them. However, it is not true.

Under Paragraph 6, Article 753 of the Russian Civil Code, the customer may refuse to accept the works performed by the contractor only if the defects revealed by it preclude the possibility to utilize the result of the works for the purposes provided for by the contract and cannot be eliminated.

According to the legal proposition formulated in Resolution of the Presidium of the Supreme Commercial Arbitration Court of the Russian Federation dated 27.03.2012 No. 12888/11, the very fact of presence of certain defects in the performed works cannot serve as absolute grounds for refusal to accept and pay for them.

A similar view is expressed in Ruling of the Supreme Court of the Russian Federation dated 27.08.2015 No. 305-ЭС15-6882, from which it flows that if there are defects which do not preclude the result of the works to be used for the purposes provided for by the contract or defects that can be cured, the customer may not refuse to accept the works, but may submit claims to the contractor based on Paragraph 1, Article 723 of the Russian Civil Code (for removal of defects, a proportionate reduction in the contract price or reimbursement of expenses incurred to remove defects, if the contract provides for the customer’s right to independently remove defects in the works performed).

As for the contractor, it does not even have to insist on the customer’s accepting the works performed, since Paragraph 4, Article 753 of the Russian Civil Code allows for collection of the cost of the works based on a unilateral certificate executed by the contractor. The customer refusing to sign the certificate (and consequently, to accept the works) will then have to justify such
refusal.

Dates for Performance of Works

One more group of construction related disputes are disputes as to the dates for performance o works. Under Paragraph 1, Article 708 of the Russian Civil Code, the contractor is liable to the customer for a failure to meet both the initial and final and interim dates for performance of works. Normally, the contractual liability for such delay takes the form of a penalty. However, if the contractor does not proceed, within the due dates, to perform the contract or performs it so slowly that a timely completion of the works becomes apparently impossible, the customer, pursuant to Paragraph 2, Article 715 of the Russian Civil Code, may waive the contract and claim damages.

In its Resolution dated June 11, 2013 No. 1396/12 the Presidium of the Supreme Commercial Arbitration Court of the Russian Federation confirmed the right of the parties to a construction contract  to establish a penalty for the contractor in the event of the customer’s unilateral waiver of the contract on the grounds provided for by Article 715 of the Russian Civil Code, and in its Resolution dated December 01, 2011 No. 10406/11 it noted that due to the customer’s unilateral waiver of the contract, no grounds any longer exist with the contractor to retain a previously made advance payment which, pursuant to Paragraph 1, Article 1102 of the Russian Civil Code, is subject to return to the customer.

It is often the case that in disputes over performance dates contractors refer to the fact that the delay is due to the circumstances which are the customer’s responsibility: untimely provision of the construction site, technical documentation, etc. But these cannot always serve as the grounds to release the contractor from the liability for its failure to meet the contractually set dates.

Under Paragraph 1, Article 716 of the Russian Civil Code, the contractor must immediately notify the customer of any events that make it impossible to complete the works within the due dates. In case the contractor fails to perform this obligation, it may no longer refer to the relevant events as the grounds to be released from the liability for the delay.

The Presidium of the Supreme Commercial Arbitration Court of the Russian Federation emphasized in its Resolution dated October 22, 2013 No. 6373/13 the necessity for the courts to evaluate the fact that the contractor, following the provisions of Article 716 of the Russian Civil Code, warned the customer of the impossibility to perform the works within the initially agreed dates.

A similar view is expressed in Ruling of the Supreme Court of the Russian Federation dated 18.08.2015 No. 305-ЭС14-8022, from which it flows that in order to waive a contract based on Paragraph 2 Article 715 of the Russian Civil Code due to an improper performance by the contractor of its obligations, the customer must inspect the works and prove that at the existing rate of performance of the works their delivery dates will not be met. In the same ruling, the judiciary mentioned that the customer’s unjustified refusal to sign the delivery and acceptance certificate for the works performed does not entitle it to refer to the fact that the works were not accepted and waive the contract on the grounds of the improper performance by the contractor of the obligations assumed by it.

In its Resolution dated September 23, 2008 No. 5103/08, the Presidium of the Supreme Commercial Arbitration Court of the Russian Federation noted that if the contractor proceeds to perform construction works in a timely manner and does so at standard rates (which fact may be evidenced based on the scope of the performed works to be established following a forensic enquiry), and then suspends them and is no longer in a position to continue construction owing to the customer’s unjustified actions provided for by Article 715 of the Russian Civil Code, the grounds for the customer’s unilateral waiver of the contract do not exist. However, the unilateral waiver by the customer in the absence of the grounds specified by Article 715 of the Russian Civil Code nonetheless results in contract termination, but based on the grounds and with effects provided for by Article 717 of the Russian Civil Code (in this event, the waiving customer is obliged to pay the contractor for the works performed and reimburse it for damages caused by contract termination, such damages being the difference between the total contract price and the portion of the work actually performed).