Slovak Republic: Ensuring contractor performance

Author: | Published: 22 Feb 2016
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Daniel Futej Cyril Hric

A practice has recently been implemented in the Slovak construction market designed to ensure that subcontractors, considered to be the weaker party, get paid for their work. Consequently, public procurers have started to require security for payments to subcontractors. In large and complex projects, it is common practice for the client to require a guarantee from the contractor that it will duly and timely complete the project. A common form of guarantee is known as retention, where the client retains a certain percentage of the invoiced sum. In Slovakia this typically ranges from five to ten percent of the total cost.

A bank guarantee is a common alternative to retention. In this case, if the contractor fails to duly and timely complete the work, the client's costs are covered by the bank guarantee. A frequent option, particularly for large construction projects, is an agreement between the contractor and the client giving the contractor the option to exchange the retention for a bank guarantee. This gives a contractor, whose client has exercised retention, the right to demand immediate payment of the retention upon presentation of a bank guarantee to the client. The bank issues the bank guarantee on the contractor's request, for the benefit of the client. Generally, the guarantee obliges the bank to pay the client on demand a sum up to the guarantee amount. Usually, before the payment is made from the bank guarantee, the bank requires the client's demand for payment and its declaration that the contractor is in breach of the contract for work. If the client calls on the bank guarantee contrary to the contract for work, the contractor will have the right to seek compensation for any damages it incurs.

The bank has no role in such a dispute, provided it pays the client in accordance with the guarantee instrument. Once a bank guarantee is issued, the relationships associated with the guarantee become completely independent of the actual contract for work.

Another common problem is that banks set specific expiry dates on performance bonds, whereas clients seek bank guarantees that will remain valid until completion of the work. Completion may be delayed for various reasons, which could result in the bank guarantee expiring before the work is completed. Because the bank guarantee is independent of the contract for work, the only option is for the contractor to arrange an extension of the bank guarantee for the necessary period of time. To avoid this situation, it would be effective if the contract for work provided an obligation for the contractor to maintain a valid performance bond throughout the duration of the work (notwithstanding the duration of the guarantee issued by the bank) and a special entitlement for the client to call on the bank guarantee if it is not extended by a specific time before its expiry. This would enable the client to call on the bank guarantee on the grounds that the bank guarantee is nearing expiry but the work is not yet completed.

This type of provision would put pressure on the contractor to ensure the bank guarantee does not expire before the work is completed, which would cause the client to lose this particular type of security. It also allows for the client to call on the bank guarantee not only in the event of a default, but also if the bank guarantee were at risk of expiring before the work was completed. In the absence of such a provision in the contract, if the client were to call on the bank guarantee the contractor could successfully enforce a claim for compensation for damages against the client.

Bank guarantee fees in Slovakia currently range from 1.5% to 2.5% of the guarantee amount per year. For the contractor, this alternative could relieve the cash-flow issue, considering that retention is anywhere from five to ten percent of the total price of the work. As issuers of guarantees, banks have the option of applying the Uniform Rules on Demand Guarantees (URDG) issued by the International Chamber of Commerce. However, this option is rarely applied in Slovakia for construction projects. Depending on the specific project, the use of URDG often requires the exclusion of some of its provisions, and banks most often use their own versions of guarantees.

Daniel Futej and Cyril Hric