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Legal ways of dealing with breaches of contract by construction companies.

In recent years, there have been numerous insolvencies and bankruptcies of construction companies, as they have found themselves in complex economic situations. This scenario has increased even more during the years 2021 and 2022, as a result of the global crisis in the commercial sector due to the lack of supplies and the consequent increase in the cost of raw materials, energy and transport. It is here that we can find the origin of the increasingly frequent conflict between the parties to a works contract, especially when they are formalised by companies belonging to the construction sector.

Revision of prices in building contracts.

There are many construction companies that, given the situation of crisis and rising costs, are demanding a price increase from the contracting party for the execution of their works.

In general terms, the law establishes that the fixed price established in this type of contract is not subject to modification in accordance with the provisions of article 1593 of the Civil Code: “The architect or contractor who undertakes the construction of a building or other work for a fixed price in view of a plan agreed with the owner of the land, cannot request an increase in price even if the price of labour or materials has been increased; but he may do so when a change has been made in the plan that produces an increase in the work, provided that the owner has given his authorisation“. In the light of this provision, the builder will only be entitled to claim an increase in the price when, with the authorisation of the owner, an increase in the work has taken place.

However, it is true that such a rule is not mandatory and that, in accordance with the principle of freedom of contract in Article 1255 of the Civil Code, the parties’ agreement in the contract regarding the contractor’s right to demand a price revision will have to be followed. 

Invocation of the rebus sic stantibus clause.

Therefore, since no price revision clause has been stipulated, many construction companies claim a price revision by using the rebus sic stantibus clause. According to this clause, the terms of the contract apply and remain unchanged “as things stand”, i.e. as long as the circumstances prevailing at the time of the conclusion of the contract do not change. The application of this clause has been the subject of numerous judicial pronouncements, which have opted for a very restrictive application of this clause.

Consequently, on many occasions it will be the courts that will have to decide on the application of the rebus sic stantibus clause. However, part of the doctrine has ruled on the matter and considers that the application of this clause is unlikely to be successful as it considers that these are not successive tract contracts, in which a single service is provided continuously over time, but rather contracts in which fixed prices are negotiated, with the construction company being aware of the possibility of this type of contingency occurring, which is why they include a margin in the price to cover it.

That said, when the construction company reaches an unsustainable economic situation, given that the application of the rebus sic stantibus clause must be backed by a court ruling and cannot be applied unilaterally by one of the parties to the contract, the construction company may find itself in a scenario of imminent insolvency, meaning that it will not be able to comply regularly and punctually with its obligations. 

Pre-bankruptcy situation of construction companies.

When this situation happens for companies, the first step they usually take is to apply for pre-insolvency proceedings, which is nothing more than notifying the court of the opening of negotiations or the approval of a restructuring plan as they are likely to become insolvent. This communication may be reserved, if the debtor so requests, so it is possible that it will not be published in the public insolvency register and, until the company files for insolvency, it will not be possible to obtain more information on the true economic situation of the debtor company.

The main concern about this economic situation is for suppliers and individuals who still maintain relations with the construction company. In this sense, those affected should be aware that the declaration of insolvency is not a cause for early termination of any contract and any stipulations that establish the power of termination or extinction of the contract due to the declaration of insolvency of the debtor are null and void. Therefore, this type of clauses introduced in the contract will be considered not to be in force, and those affected will be able to continue claiming in accordance with the general regulations.

It should be remembered that the essential principle in insolvency matters is continuity, so that the pre-insolvency situation or the declaration of insolvency does not interrupt the continuity of the business activity, and therefore, neither does it suspend or render ineffective the contractual framework of the company.

Effects of contracts after the declaration of insolvency.

In effect, the declaration of bankruptcy will not affect the validity of the contracts with reciprocal obligations pending fulfilment by both the debtor and the other party, i.e. the construction company must finish the works pending, while the supplier or individual must continue to pay the prices agreed in the contract, if the fulfilment of the same is still pending.

In the event that the individual or supplier does not wish to continue with the contract, he will always be able to terminate the contract due to non-performance by the debtor. This point is important to highlight, in view of the options that individuals and suppliers may have against the debtor who, it seems, is not yet in insolvency proceedings. This is because, once the insolvency proceedings have been declared, the rule only allows those affected by a breach by the debtor prior to the insolvency proceedings to request the termination of the contract, if they have a successive contract. Generally, construction contracts are not of successive tract (as already mentioned in this article), but of single tract, which means that the performance is a future result, which is the materialisation of the work.

Consequently, the creditors, once the insolvency proceedings have been declared, will not be able to terminate the contract; they will only be able to report the amount owed by the insolvent party as a credit in the insolvency proceedings. Having said this, it may be advisable to file a lawsuit requesting the fulfilment of the company’s obligations and, subsidiarily, to request the termination of the contract, because these actions carried out prior to the insolvency proceedings will not be affected by the debtor’s insolvency situation, since the lawsuit filed will continue its usual channels.

Responsibility of administrators.

We should also remember that there are a series of actions that can be brought against the company’s directors, if a series of legal requirements are met. This option can be very positive, since if the administrators have not fulfilled their duties, they will be liable with their own assets, thus guaranteeing that creditors will be able to seize the administrators’ assets to satisfy their claims. However, before being able to take action against the administrators, the affected party must obtain a favourable ruling against the company. 

For all these reasons, it is advisable to seek advice, both prior to the formalisation of the contract and at the time of resolution of any possible contingencies that may arise between the parties, especially when it is known that the construction company may be in a situation of imminent insolvency.

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