Insolvency of the general contractor - solutions for real estate developers and projects

2019 | academic and other publication

When an insolvency procedure is initiated against the general contractor of a real estate project it can generate many technical, financial and legal difficulties. Its impact on the developer's image and the market's view of the project itself cannot be underestimated, given the public uncertainty about the developer's ability to complete the construction works.

1. Objective of the insolvency procedure

The insolvency procedure operates according to Law No. 85/2014 on insolvency prevention and insolvency procedures ("Law 85/2014"), which repealed Law No. 85/2006 on the insolvency procedure ("Law 85/2006"). Although repealed, Law 85/2006 is still applicable, because Law 85/2014 does not apply to procedures that were already underway when the law entered into force.

According to the applicable legal provisions, the objective of the insolvency procedure is to establish a collective procedure to cover the debtor's debts. The aim is to grant the debtor, when possible, the chance to rebalance its activity.

Although the intention was to create a balance between the interests of the creditor seeking to recover its receivables as soon as possible and the possibility to save the debtor, in reality the debtor has a certain priority when it comes to saving its business, at the expense of the creditor's right to recover its receivables.

2. The impact of the insolvency procedure

From the perspective of the possible impacts of the insolvency procedure against the general contractor of a real estate project, we underline the following:

2.1 With respect to the right of the developer to terminate the construction agreement

According to the applicable legal provisions, agreements that are ongoing are considered to be in force at the date the insolvency procedure was initiated, regardless of whether the insolvency request was submitted by the debtor or the creditor(s).

Also, clauses regarding the termination of ongoing agreements, of limitation from the benefit of the term or the declaration of anticipated chargeability, based on the initiation of the insolvency procedure against the debtor, are qualified as null.

Nevertheless, the developer has the right to request the insolvency practitioner to terminate the construction agreement within the first three months after the initiation of the insolvency procedure based on a written notice.

It is important to remember that the decision regarding the termination or the maintaining of the construction agreement is to be rendered by the insolvency practitioner, who is obliged to answer the applicant within 30 days of receipt of the notice. If it fails to do so, the right of the insolvency practitioner to request the performance of the agreement is no longer applicable, as the agreement is considered terminated upon the expiry of the 30-day term.

Should the general contractor fail to perform its contractual obligations, the real estate developer has the right during the insolvency procedure to ask the syndic-judge to terminate the construction agreement.

2.2 With respect to the right of the insolvency practitioner to terminate the agreements

The objective of the insolvency practitioner is to maximise the value of the debtor's property. Therefore, the insolvency practitioner can unilaterally decide (i) to maintain the ongoing agreements or (ii) to terminate such agreements, within a limitation period of three months, as of the initiation of the insolvency procedure.

From this perspective, the right of the insolvency practitioner to unilaterally terminate the debtor's ongoing agreements within the insolvency procedure is an exception from the principle according to which the agreements are binding between its parties.

The insolvency practitioner cannot terminate agreements that have been entirely or substantially performed by the parties.

Therefore, if the insolvency practitioner determines that the maintaining in force of the construction agreement does not comply with the objective of maximising the value of the debtor's property, the insolvency practitioner can terminate the agreement.

In this case, the real estate developer has the right to submit a claim for damages against the general contractor that will be considered an unsecured receivable.

3. Potential measures to limit the effects of an insolvency procedure initiated against the general contractor

In order to limit the unpleasant effects of an insolvency procedure against the general contractor, we recommend that real estate developers consider the following measures:

3.1 Obtaining a bank guarantee letter

The obligation of the general contractor to provide the real estate developer a bank guarantee letter is an efficient mechanism to ensure the execution of the general contractor's obligations. It is a good idea to include the draft of the bank guarantee letter that the general contractor must provide to the real estate developer as an annex to the construction agreement.

3.2 Retention of amounts from the final invoice or regular retentions from due invoices

Another method to limit the risk caused by the general contractor's insolvency is for the real estate developer to retain a certain percentage from the amount of the regular invoices issued by the general contractor or from the final invoice, depending on the corresponding legal provisions.

3.3 Obtaining contractual guarantees from the parent company

If the general contractor is a member of a group of companies, the real estate developer can request and obtain a contractual guarantee from a different entity in the group for the performance of the subsidiary's obligations under the construction agreement.

However, such precautionary measures are not infallible, because in certain cases the subsidiary's financial problems may be a symptom of the general condition of the entire group.

3.4 Direct payment of the subcontractors by the real estate developer

The construction works on the project can continue if the construction agreement contains provisions allowing the real estate developer to make direct payment towards the subcontractors if the general contractor cannot do so.

4. Conclusions

The diligence that the real estate developers demonstrate when choosing their contractual partners, negotiating and signing the construction agreements, and determining the mechanisms for ensuring the observance of the corresponding obligations by the general contractor are a decisive element which may determine the completion of the project and its success in the market.

An insolvency procedure initiated against the general contractor may justifiably lead to mistrust on the part of clients and/or potential clients and negative impacts on the reputation of the real estate developer, the real estate project and even future real estate projects. Real estate developers may thus find themselves in the unpleasant situation of having to rethink their business strategy and to find remedies that are almost always costly.

Taking precautionary measures prior to signing a construction agreement could limit the negative impacts of a potential insolvency procedure against the general contractor of a real estate project.  

 

This article was first published in the report Residential Market Genome 2019, edited by SVN Romania.

Emeric Domokos-Hancu

Local Partner

T: +40 21 319 67 90
e.domokos@schoenherr.eu

Linkedin

Oana Sarbu

Attorney at Law

T: +40 21 319 67 90
o.sarbu@schoenherr.eu

Linkedin

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romania

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SVN Romania | Residential Market Genome 2019