CHANGE OF REMUNERATION IN PUBLIC CONSTRUCTION CONTRACTS
Surging prices for construction materials, an inflation rate that is highest in years, and spiralling operating costs are a major headache for construction companies at the moment. The problem is particularly acute when it comes to putting together project cost estimates, as it has become all but impossible to predict with any precision future prices of major cost components and, consequently, the overall project cost. This article looks at the issue of change of remuneration in construction contracts in Poland, focusing in particular on construction works contracts awarded under the public procurement regime. There is no doubt that the contract valorisation provisions of the Public Procurement Act have an immense impact on the entire construction market. The objective of the mechanism is to reduce the high risk of cost escalation borne by firms that bid for, and receive, construction works contracts from public entities, by permitting modifications to the overall contract price to reflect cost increases. Therefore, understanding its practical aspects can help economic operators to manage their risks better and execute projects more efficiently.
Change of remuneration has a considerable history in Polish law, and is well established in the country’s public procurement regulations. Both the Public Procurement Act of 29 January 2004 (henceforth “old PPL”) and the law that superseded it, the Public Procurement Act of 11 September 2019 (henceforth “current PPL”), contain provisions on change of remuneration.
Under both old PPL and current PPL, change of remuneration is distinct from a change of public contract by mutual agreement. As has been repeatedly pointed out in both legal doctrine and practice, in the event of a genuine increase in the cost of performing a contract, the economic operator is entitled to seek a commensurate increase in the contract remuneration.
Under old PPL (Article 142), change of remuneration was permissible only in cases specifically indicated by it, however, which set it apart from price adjustment as laid down in the Civil Code (Article 3581). Furthermore, old PPL put the onus on the economic operator to prove that e.g. an increase in the prices of construction materials affected the cost of performing the contract.
Although old PPL included mechanisms to prevent gross imbalances of contractual power between contracting authorities and economic operators, and the placing of excessive risk on economic operators, its provisions proved an insufficient safeguard. To address that, current PPL introduced significant changes.
The part of current PPL that deals with change of remuneration is Article 439. Under it, any public construction works contract longer than 12 months has to include a change of remuneration clause that provides for the adjustment of the contract price to account for changes in the prices of materials or other cost components of performing the contract. In shorter contracts, change of remuneration clauses are optional, although in the prevailing market conditions it appears they should be widely used in such contracts, too.
Article 439 then sets out elements that the change of remuneration clause of a public construction works contract should contain.
First, it should specify what extent of changes in materials prices or other cost components of the contract will trigger change of remuneration, and what the initial date of determining the change of remuneration will be (Article 439 paragraph 2 item 1)).
“The initial date of determining the change of remuneration” deserves special attention, for the expression is not precise and has raised interpretive problems. There are two major alternative interpretations. One is that it is the date from which the changed remuneration applies. The other is that it is the baseline date, i.e. the date with reference to which cost data will be analysed to determine the extent of changes. The latter interpretation appears more justified; it is also more often used in practice.
“The level of change in the price of the materials or costs” also requires explanation. It refers to the prices for any materials, or any other costs that affect the overall cost of performing a contract, so it covers prices for raw materials, construction materials, electrical supplies, installation materials, finishing materials, etc., but also e.g. prices for fuel or waste disposal, as well as the costs of services that go into delivering a contract, including labour costs. It is common for contracting authorities to express the extent of changes in percentage terms.
A remuneration change clause also has to specify “the method of determining the change of remuneration” (Article 439 paragraph 2 item 2). The provision says that the change of remuneration can be based on indices of costs or prices, such as those published by the Central Statistical Office (GUS), or some other point of reference, e.g. a mutually agreed list of materials or other cost components whose price changes can trigger change of remuneration.
Future economic operators should pay special attention to this aspect, because in the case of contracts in which the contract price is one lump-sum amount, using price and cost indices from publications such as Sekocenbud or Katalogi Nakladow Rzeczowych can lead to disputes with the contracting authorities. These indices should be used for change of remuneration in cases where there is a breakdown into cost components. Using GUS indices is effective in the case of bill-of-quantities type of contracts, or more detailed schedules of works and expenditures.
The option that the contracting authority chooses should be appropriate to the nature of the project, and should also correspond to knowledge of market. Failure to give proper consideration to these matters can significantly reduce the number of bidders.
Thirdly, a change of remuneration clause has to specify the way of establishing the impact of changes in materials prices and other cost components on the overall project cost, and indicate time periods when change of remuneration can be made (Article 439 paragraph 2 item 3)). This is especially important in the case of raw materials prices, which are subject to major seasonal fluctuations. But in the current highly volatile and uncertain environment, amid the supply chain disruptions of the pandemic, change of remuneration may have to be conducted more frequently for other items, too.
Finally, a change of remuneration clause must necessarily specify the maximum change in the contract price permitted by the contracting authority (Article 439 paragraph 2 item 4). This requirement, which runs counter to the spirit of the other provisions, is meant to ensure that contracting authority maintain financial discipline. Again, however, with the volatility that now characterises many markets, it may easily cause unwanted consequences for contracting authority if not used carefully. Economic operators should begin their risk assessment by examining this part of the change of remuneration clause.
In the current volatile circumstances, both economic operators and contracting authorities are facing unprecedented challenges when assessing business risk, as regulations and contract terms are repeatedly overtaken by events. It should be noted that change of remuneration clauses do not eliminate business risk but merely reduce it, since not every change in materials prices or other project costs will trigger change of remuneration in the contract.
Tomasz Mielko is a lawyer with the Warsaw office of Miller Canfield. He specializes in defence and security matters, public procurement law and international export compliance.