A legal way to protect oneself against contractor’s insolvency in the Czech Republic

A simple contractual clause – which the Czech Supreme Court has now confirmed to be perfectly lawful – can save clients a lot of money and hassle if their contractor goes bust. What is this contractual clause which (from the point of view of clients) ought to be included in every contract for work?

As a rule, the insolvency of a contractual partner is hardly a foreseeable event; as such, it may cause businesses a lot of trouble and hamper their smooth operation.

Contract for work

The insolvency of a contractor is particularly unpleasant if they completed a large-scale work for the client (say, a building) and granted a long-term warranty to the client for the quality of the work.

Unless the client arranged in the contract for work for a bank bond or other third-party guarantee to secure the contractor’s performance under the warranty, they will usually forfeit the warranty altogether, without recourse, if the contractor becomes insolvent. After all, an insolvent contractor will usually be unable to honor their obligations under the warranty (and, in subsequent stages of the insolvency procedure, will be even prohibited from doing so). At the same time, the warranty granted by the contractor often represents a substantial portion of the price for work, and the terms on which it was granted (i.e., in particular, the scope and duration of the warranty) are often a major factor in choosing one contractor over another.

Agreement on a discount on the price for work

Fortunately, there exists a relatively straightforward way how to eliminate (or at least reduce) the adverse consequences associated with the contractor’s insolvency and the potential loss of claims under the warranty granted by them. The parties may agree on a clause in the contract for work to the effect that the contractor’s insolvency triggers a discount on the price, in the amount of the retainer withheld by the client, if the warranty can no longer be invoked because of the said insolvency.

This solution is neither new nor revolutionary: seasoned clients have for quite some time insisted on incorporating similar clauses in their contracts for work (though, it must be said, with varying success).

What does the Supreme Court have to say?

In the past, insolvency trustees have sometimes successfully contested such arrangements in bankruptcy or insolvency proceedings, arguing that they were null and void on grounds of being unlawful and being in violation of the principles governing insolvency proceedings – i.e., specifically, the principle of non-discriminatory treatment (because they curtail the degree to which other creditors of the insolvent contactor will attain satisfaction). However, in a recently published decision, the Supreme Court has upheld this kind of contractual clause as valid. With reference to the principle of autonomy in contracts, the justices expressly stated that, “the Supreme Court is convinced that an agreement between the parties whereby the price for work shall be reduced by the value of a warranty that was not exercised (i.e., by the amount of the agreed retainer) in the event of insolvency on the part of the contractor is not in opposition to the law, nor does it represent a circumvention of the law or in any way violate the principles of insolvency proceedings“.

In other words, contractual parties may now freely agree in the contract for work to slash the price for work by the amount of the as-of-yet unused retainer if the contractor becomes insolvent, as a form of compensation for the warranty that was not exercised and that has been “frustrated” by the said insolvency. With a bit of creative legal thinking, this kind of contractual clause could be modified so as to be useful also in other types of contract where a long-term warranty is being granted.

Having this in mind, we may generally recommend that clients consider the possibility of a future insolvency of their business partner from the get-go, and incorporate clauses in their agreements in order to mitigate or eliminate the negative consequences associated with such an event. Drafting these clauses is best left to an experienced attorney.

Supreme Court Judgment 29 Cdo 561/2017 of 25 March 2019


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