This post is part of a series covering issues that frequently arise in construction law disputes, each with a specific regional focus. This post addresses issues in Russia.
The Russian construction sector has experienced significant activity in recent years. The COVID-19 pandemic has resulted in a projected contraction of the construction industry in Russia by 3.8% in 2020 (as opposed to the 2.6% growth expected prior to the virus outbreak). However, the Russian government remains focused on continuing with infrastructure works, as President Putin confirmed in April 2020, when he urged senior government and business officials to “adhere to infrastructure project schedules as closely as possible”.
Russian parties seldom make use of internationally recognised standard forms (such as the FIDIC suite of contracts), as such forms usually are not compliant with Russian law and so require major redrafting. Instead, tailored contractual documents compliant with the provisions of (for example) the Civil Code of the Russian Federation (Russian Civil Code) are much more common.
This post considers two important restrictions under the Russian Civil Code, affecting an employer’s ability to vary the scope and/or value of works and a contractor’s/sub-contractor’s ability to recover sums in excess of the agreed contract price for the performance of additional works.
Article 744 of the Russian Civil Code – variation initiated by the employer
Article 744 of the Russian Civil Code permits an employer unilaterally to vary technical documentation and therefore, to an extent, the scope of works. However, such variations may not exceed “in cost terms 10 per cent of the total estimated cost of construction“, nor “change the nature of the works envisaged in the construction contract”.
The phrase “estimated cost of construction” refers to a formal construction cost estimate (“smeta”), which Russian law requires the contractor to prepare and which is an essential term of the construction contract. Accordingly, as confirmed in Article 744(2), changes made to the technical documentation that will have a cost impact greater than 10% will require an amendment to the smeta by agreement with the contractor. As a general rule, this will take the form of a supplement to the construction contract.
At the same time, the law does not provide for a clear answer on whether additional works caused by an employer’s unilateral changes to technical documentation should be paid if their cost does not exceed 10% of the total estimate cost of construction. However, the current trend in court practice is to support an approach where payment is required even if the cost of additional works is up to 10% of the contract price.
For example, the Supreme Court of the Russian Federation (in ruling number 302-ЭС18-17491 on the case No. А19-5999/2017 dated October 26, 2018) and the Arbitrazh (Commercial) Court of the Ural district (in ruling number Ф09-6369/15 on the case No. А60-24553/2014 dated September 21, 2015) confirmed the lawfulness of recovery by the contractors from the employers of the cost of additional works that do not exceed 10% of the total estimated cost of construction. Such approach conforms with the principle of good faith since such additional works result in an economic or other benefit to the employer.
Article 743 of the Russian Civil Code – variation initiated by the contractor
Russian law treats variations initiated by the contractor in a different manner. As a default, variations exceeding 10% are subject to the procedure set out in Article 743 of the Russian Civil Code and relevant court practice, which requires the contractor to show:
- The actual necessity of the performance of the additional works.
- Proper notification by the contractor of the necessity of the additional works.
- The employer’s consent for the performance of the additional works.
- The actual performance of the additional works, their scope, their cost and the existence of their “economic value” for the employer.
If a contractor determines that additional works are required in excess of the scope set out by the technical documentation and smeta, it must formally notify the employer or higher tier sub-contractor of the required additional works. If the contractor does not receive a response from the employer within ten days (or another period provided for in the contract between the parties), or the employer rejects the claim or asserts that the works are not additional, the contractor must put on hold such additional works and may charge the employer any losses caused by the downtime from the employer’s decision. The contractor, however, is not entitled to put on hold the rest of the works and must continue with the original scope of the works. The employer will not be liable to the contractor for damages if it proves that the additional works were unnecessary and did not result in an economic or other benefit to the employer. To prevent disputes as to the additional nature of, or the necessity for, the varied works, it is prudent to specify precisely in the contract the criteria for consideration of works as additional and a procedure for their approval and verification by the employer.
Alternatively, the employer might agree that the proposed works are necessary but assert that they are already covered by the contract. This situation is not covered by Article 743, and the dispute will be resolved by the interpretation of the contractual provisions. The contractor may suspend all works under the agreement and initiate court proceedings if the employer rejects its application for approval of additional works. However, in this case, the contactor takes on a huge risk – if it loses the dispute in court, depending on the agreement provisions, it might be liable to pay the employer damages and penalties for the delay. In most cases, the employer will also have a right to unilaterally terminate the agreement. In practice, contractors usually continue the works, reserving their right to recover payment.
A contractor who commences additional works and fails to follow the Article 743 procedure will forfeit its right to claim payment for the additional works or compensation for any resulting losses unless the contractor can show that the immediate commencement of the additional works was in the interest of the employer or higher tier sub-contractor. For example, Article 743(4) provides for the situation in which suspension of the works could lead to the destruction of or damage to the project (see ruling No. 309-ЭС18-24633 on the case No. А60-56331/2017 dated February 08, 2019; No. 306-ЭС20-6454 on the case No. А65-6646/2019 dated May 08, 2020).
In two recent cases, the Supreme Court of the Russian Federation (the “Russian Supreme Court”) denied a sub-contractor’s claim for payment for additional works because the sub-contractor had failed to follow the Article 743 procedure. In both cases, the respective sub-contractor had carried out additional works, and it was accepted that this entailed additional expenses. However, in both cases, the Russian Supreme Court ruled that these expenses could not be passed on to the employer or higher tier sub-contractor as Article 743 envisions a strict adherence to the “firm” fixed price set out in the smeta. Deviations from this fixed price necessarily require compliance with the Article 743 procedure.
While the law does not expressly state that this procedure can be contractually modified, it is arguable that such modification should generally be possible.
The employer must consent to the performance of the additional works in a form compliant with Article 743, for example through signing a works completion certificate or similar. However, it is unnecessary for a supplemental agreement to the construction contract to be agreed by the parties. As the Supreme Arbitrazh (Commercial) Court of the Russian Federation has clarified, actual acceptance by an employer of works in the absence of an executed construction contact constitutes a ground for recovery of unjust enrichment from an employer in favour of a contractor (clause 6 of the Informational Letter of the Supreme Arbitrazh (Commercial) Court of the Russian Federation No. 127 dated November 25, 2008). The lack of a supplemental agreement to the construction contract therefore does not relieve an employer from payment for additional works if the additional works are of “economic value” for an employer, and an employer intends to make use of them (Resolution of the Arbitrazh (Commercial) Court of the Volga district No. Ф06-59959/2020 on the case No. А65-32923/2017 dated August 21, 2020; Resolution of the Arbitrazh (Commercial) Court of the Volga district No. Ф06-51012/2019 on the case No. А65-15373/2018 dated September 18, 2019).
Article 743(5) also sets forth two situations when a contractor has the right to refuse to perform additional works even if an employer’s consent is obtained. A contractor is permitted to do so if:
- Such works are not covered by a contractor’s professional activities area.
- Such works cannot be performed by a contractor due to reasons which are beyond the contractor’s control (for example, if a supplier is not able to deliver required materials and/or equipment in a short time).
For parties accustomed to extensive contractual provisions, such as those found in international standard-form contracts, it is important to take note of how Russian law-governed construction contracts are affected by the requirements of the Russian Civil Code. Articles 743 and 744 of the Russian Civil Code provide an important example of this practice. Aside from imposing a cap on variations of the scope of works via changes to the technical documentation, parties will be strictly bound by the contract price agreed in the smeta, subject to compliance with the Article 743 procedure.
Therefore, parties should not expect the construction contract to govern the project exhaustively and are advised to familiarise themselves with any provisions of Russian law that may apply to them.