Payment guarantee – can it always serve as an effective security in the process of removing defects?

The case recently handled by the Law Firm’s lawyers involved the issue of removing numerous defects in residential construction projects carried out separately under three construction contracts.

The investment was staged, with each stage involving the construction of residential buildings and accompanying infrastructure (completing the entire housing estate). All three stages of the project were completed and accepted, but a long list of defects remained to be corrected.

As is often the case in such situations, the contractor partially removed the defects but refused to correct the remaining ones, claiming that the cause of the defects lay in the faulty project documentation provided by the investor during the construction process.

Despite discussions between the investor and the contractor with the involvement of lawyers, and expert reports supporting the claims, the dispute remained unresolved. The buyers of the apartments had been waiting impatiently for the removal of the significant defects in the estate’s infrastructure, and the negotiations and arrangements dragged on endlessly.

When the investor eventually brought the case to our Law Firm, considering it a dispute that required judicial intervention, we conducted a detailed legal analysis of both the content of the individual construction contracts and the guarantees provided by the contractor at the time of signing the contract and later during the final acceptance of each stage (covering the warranty and guarantee periods).

The contracts clearly stated that in the event the defects reported during the warranty and guarantee period were not removed on time, the investor would have the right to commission another entity to correct the defects at the contractor’s cost and risk (known as substitute performance). This contractual provision, correctly formulated, in line with the position of the Supreme Court and common courts, allowed us to partially avoid the issue of seeking judicial authorization for the investor to carry out substitute performance under Article 480 of the Civil Code.

The separate issue was determining how to remove the defects as quickly as possible and secure partial or full financing for the investor. According to the annexes to all three contracts, the contractor was obliged to provide a bank or insurance guarantee from a reputable bank/insurer approved by the investor at the time of final acceptance. The guarantee template was attached to each of the contracts.

A separate legal analysis of all three guarantee documents, whose validity depended on the date of final acceptance of each stage of the investment, led the lawyers to conclude that only two of them could be used effectively to claim the guarantee amount on behalf of the investor. Although all three guarantees were issued by the same guarantor, they had different content.

While the first two guarantee documents were unconditional and payable on first demand, after fulfilling the minimal requirement of providing documents related to the existence of defects and notifying the contractor to correct them, the third guarantee document required the investor – as the beneficiary of the insurance guarantee – to submit a written statement that the requested amount was “undisputed.” Given the course of negotiations with the contractor and his position on the cause of the defects, it was clear that the investor could not make such a statement without exposing itself to significant legal consequences.

In this situation, with the investor’s consent, the lawyers took action in accordance with the terms of the guarantee and obtained a significant sum from the insurer within the specified time frame, which was used for substitute performance.